Incoterms_® and Commercial Contracts

Executive Summary

While a large proportion of trade is now conducted under the rules of regional and preferential trade agreements, the core disciplines of the GATT still underpin the international trade system and many of these disciplines are an integral part of regional trade agreements. These core disciplines are easy to understand:

1) The system is tariff based:

• International trade rules permit Members to apply import tariffs. WTO Members have outlawed all absolute import quotas, though two-level tariffs, known as tariff-rate quotas,1 are permitted and are common in the agricultural sector.
  • Tariffs discriminate against imported goods – tariffs generally make imported inputs more expensive and therefore protect domestic producers of similar goods from competition, giving them an incentive to raise the price of products protected by tariffs.
  • Tariffs can result in an increase in the price of domestically produced goods that incorporate imported components that are subject to a tariff or that require imported machinery for their manufacture.
  • While there is no absolute limit on the tariff level, WTO Members have negotiated a maximum “bound” tariff rate on most products. Tariffs may not be raised above the bound rate. During the GATT era, GATT parties greatly reduced most of their bound rates as a result of various “rounds” of tariff negotiations.
  • Members are free to apply tariffs that are lower than the bound rate. The “applied” rate is often a good deal lower than a Member’s bound rate, particularly in developing countries. A Member is permitted to raise a tariff as high as the bound rate where necessary to protect domestic manufacturers (or raise revenue).
• Regional Trade Agreements (RTAs), in the form of free trade agreements or customs unions, eliminate tariffs on trade of most goods between countries that are party to the Agreement. This is one reason why industry should first examine whether exports (or imports needed for production) qualify for tariff-free treatment under an RTA.
• Preferential Trade Arrangements (PTAs) allow many imports from developing countries to enter developed countries at reduced or zero tariff rates.
• Quotas and other non-tariff measures are generally prohibited. Import licensing, which can operate as a barrier to imports, is subject to disciplines contained in one of the specialised Uruguay Round agreements. [Page42:]

2) Trade in goods must be conducted on a non-discriminatory basis:

• Under the Most-Favoured-Nation (MFN), principle imports from all WTO Members must be treated equally in terms of tariffs and internal taxes, and for regulatory purposes. For example, the United States cannot subject two competing luxury cars (e.g., a Lexus sedan from Japan and a Mercedes sedan from Germany) to different tariffs or regulations, unless a GATT exception applies. Under the National Treatment principle, imported goods must be treated at least as favourably as “like” domestic goods once they have entered the country.
• Under this requirement, the United States government cannot subject imported Lexus and Mercedes sedans to a higher excise tax or more stringent technical regulations than those it applies to a Cadillac produced in the United States, again unless an exception applies.

3) The rules governing international trade must be transparent:

The transparency provisions of the WTO Agreements, and those of most regional trade agreements, require publication of each country’s laws and regulations affecting trade. In some areas laws and regulations must be notified to the other Members, who must be given the opportunity to comment on proposed new regulations. In addition, administrative decisions on many trade matters must be subject to review by courts or other independent tribunals so that businesses have a way to challenge decisions that affect them adversely. Transparency rules allow businesses to evaluate the effect of domestic and foreign tariffs, taxes and technical regulations that may affect their international trading activities.

4) Exceptions:

The GATT Agreement contains exceptions that permit the formation of RTAs. Developed countries are permitted to grant tariff preferences to imports from developing countries. The GATT also contains exceptions that make it possible to protect (among other things) human, animal and plant life or health, public morality, and the environment (conservation of exhaustible natural resources) and national security.

* Patrick F.J. Macrory and Arthur E. Appleton are Partners in the law firm of Appleton Luff, based in Washington, DC and Geneva respectively. Mr Macrory is also Director of the International Trade Law Center at the International Law Institute in Washington, DC, DC. Dr Appleton is also an Adjunct Professor at the Johns Hopkins University School of Advanced International Studies (SAIS-Europe).

1.0 Introduction

This chapter discusses the rules developed under the General Agreement on Tariffs and Trade (GATT), which still serve as the backbone of the modern trading system. Although the World Trade Organization (WTO) superseded the GATT as an institution on 1 January 1995, the GATT is still in effect as one of the WTO Agreements. The GATT is important to businesses as it contains the fundamental rules that underpin the international trading system, as shown by the fact that more than four-fifths of the more than 500 dispute settlement cases filed with the WTO since 1995 were based at least in part on alleged violations of the GATT. The rules are designed to prevent WTO Members from undercutting the value of the tariff reductions they have made in the multilateral negotiating process by, for example, imposing quantitative limits on imports or enacting domestic regulations that discriminate in favour of local products. These rules provide a degree of certainty and stability for both foreign and domestic producers, assuring that they will be treated more or less equally. This is important as it allows business to plan investment and production decisions and to identify trading partners.

The following hypothetical example illustrates the types of business issues that the GATT Agreement was designed to address and still addresses as part of the WTO Agreements:

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Exxo company produces electric kettles in the United States. The innovative design means that Exxo’s kettles boil water faster and use less electricity than their competitors. Exxo conducted a survey that demonstrated that the demand for electric kettles is strong in China, and that prices are high. Based on its superior technology and the results of its survey, Exxo would like to export its kettles to China. However, before doing so, Exxo should ask the following questions, each of which has significant cost implications and which may affect Exxo’s ability to compete effectively in China.

• Will Exxo’s electric kettles have easy access to the Chinese market, or will they face high tariffs or other restrictions such as numerical quotas?
• Assuming that Exxo’s electric kettles can enter the Chinese market, will the Chinese government impose discriminatory taxes or regulations that favour either locally produced electric kettles or imports from other countries?
• Are applicable Chinese laws and regulations transparent – will Exxo be able to determine the applicable rules from publically available sources?

If the answer to any of the above questions is unfavourable, or if a business that is already exporting to a WTO Member finds that its products are subject to increased restrictions, such as a higher tariff, a numerical quota, new regulations that are difficult or expensive to meet, or if Exxo is unable to ascertain the applicable rules, it should seek advice as to whether such treatment can be challenged under the WTO Agreements or under any applicable regional trade agreement. In most instances, businesses must work through their governments if they wish to formally challenge tariffs, quotas, and tax and regulatory matters that violate the WTO Agreements or an applicable regional trade agreement.

Although the WTO rules remain important, before businesses seek to export goods and services they should examine whether their exports will benefit from cost advantages (preferential tariff and regulatory treatment) available under the rules of a regional trade agreement (free trade agreements such as the North American Free Trade Agreement [NAFTA] or customs unions such as the European Union), or under a preferential trade arrangement giving preferred treatment to imports from developing countries, such as the Generalised System of Preferences (operated by most developed countries), the EU’s “Everything But Arms” programme, or the US “African Growth and Opportunity Act”. Such agreements and arrangements are now powerful drivers of trade.

2.0 Tariffs and Other Border Measures

When goods are imported into a country, the customs authorities determine what tariffs or customs duties, if any, are owed, and ensure that imported products are not banned from entry, such as pornographic materials, narcotics, or products that infringe certain intellectual property rights. Imported products may also be subject to inspection at the time of entry to ensure that they comply with relevant health and safety requirements. Customs authorities may also determine whether imported goods are subject to licensing requirements. As discussed in Section 5.3 of this Chapter, import licensing can be legitimate, but is sometimes used as an illegitimate means of restricting imports – thus protecting business interests in the country that issues the license.

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2.1 The Nature of Tariffs

Tariffs (or customs duties) are a form of tax levied by governments on the importation or exportation of goods. Import tariffs were once an important source of revenue for advanced countries. As recently as 1912, before the United States introduced an income tax, customs duties on imported products accounted for around one-third of US Government revenue. This is no longer the case; tariffs now make up less than 1% of US Government revenue.²Tariffs nevertheless remain an important source of income for some least-developed countries.³

Although rare, some WTO Members levy tariffs or taxes on the export of goods – in particular natural resources and agricultural goods. Members do this primarily to encourage businesses to process and add value to natural resources locally, or to assure an adequate supply of staple agricultural products (food security). Although WTO rules do not prohibit measures of this sort, some new entrants into the WTO (in particular China) were required to eliminate or restrict such measures as a condition of entry.

2.2 Tariff Schedules

Every country maintains a tariff schedule setting forth its tariff rates for all imported products.

WTO Members file their tariff schedules with the WTO Secretariat in Geneva. Businesses can find the tariff schedules of all WTO Members on the WTO website.⁴

Each WTO Member (and some non-members) classify products based on the international Harmonised System of Tariffs, but the actual tariff rate imposed by the Member is determined either through negotiations between Members, or by a unilateral decision of the Member. Customs issues, including classification and valuation are discussed in Chapter Three.

In principle, WTO Members should apply the same tariff treatment to other Members. This is called “most-favoured-nation” (MFN) treatment, and is discussed in Section 6.2 below. In reality, there are important exceptions that mean that MFN is now the least advantageous tariff treatment available between and among WTO Members. For example, as mentioned earlier, there is an exception for regional trade agreements (RTAs) such as free trade agreements and customs unions. When two WTO Members are also parties to a free trade agreement (such as NAFTA) or a customs union (such as the EU), they usually reduce most tariffs between them to zero. Likewise, there is an exception for preferential trade agreements (PTAs). For example, under a programme called the Generalised System of Preferences (GSP), more advanced WTO Members often grant developing countries a tariff preference (a lower tariff or duty-free entry) designed to produce jobs in developing countries by encouraging these countries to produce more goods for export.

Businesses should therefore first ascertain whether a product is eligible to benefit from more favourable treatment under an RTA or a PTA, and then determine whether, from a cost perspective, it is better to take advantage of MFN treatment or preferential treatment. In some instances, the administrative costs of gaining preferential treatment outweigh the benefits of the more favourable tariff treatment that may be available under an RTA or PTA.

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The tariff schedules of developed countries are often complex with tariff treatment varying based on minor differences.⁵Such distinctions may reflect specific business interests, in particular the interests of businesses with effective lobbyists. On the other hand, the tariff schedules of developing countries are often relatively simple. Developing countries frequently employ a band system, with a certain level of tariff (say 5%) on raw materials, a higher tariff (say 10%) on components and semi-finished products, and the highest tariff (say 20%) on finished articles.

2.3 Ad Valorem vs. Specific Rates

Most duties are ad valorem, i.e., they are expressed as a percentage of the value of the good. However, the duties on some products are based on quantity, weight, or volume, and are known as specific rates. They are much less common than ad valorem rates, and most often are applied to relatively fungible products, such as fruits and vegetables.⁶ For example, the US tariff on avocados is 11.2 cents per kilogram.⁷

Ad valorem rates are more transparent than specific rates, and they are by their nature automatically linked to inflation. It is more difficult for business to determine the protective effect of specific rate tariffs. Without knowing the price of avocados, a duty of 11.2 cents/kg has little meaning. Furthermore, specific-rate tariffs need to be changed periodically to keep pace with inflation. On the other hand, specific rates are much easier for customs officials to apply, since, as discussed in Chapter Three, determination of value can be a difficult task.

2.4 Tariff Escalation

Many countries impose relatively low (or zero) tariffs on raw materials, higher tariffs on semi-finished products, and even higher tariffs on finished products. For example, in the case of coffee, tea and spices, the EU tariff rises from 0.11% on raw material imports to 8% on the final product, and in the case of Japan from 1.63% to 20%. This type of structure is known as “tariff escalation”, and is designed to make imports of final products more expensive in order to encourage businesses in the importing country to engage in processing and assembly operations.

Some developing countries view tariff escalation as a mechanism that perpetuates colonial trade patterns, and have attempted to eliminate or at least minimise it in WTO negotiations. These efforts have met with only limited success.

2.5 Tariff-Rate Quotas

Tariff-rate quotas (TRQ) are two-level tariffs, with a relatively low tariff on a specified quantity of imports (the in-quota amount), and a higher (often prohibitive) tariff on imports after the initial quantity has been imported (the out-of-quota amount). They are common in the case of agricultural products. If the out-of-quota tariff is sufficiently high, a TRQ may act as an absolute quota.⁸TRQs do not fall within the Article XI ban on quotas. However, the upper tariff rate must be within the bound rate.

2.6 Determining the Amount of Duty

Determining the amount of duty owed on imports involves several steps. First, the customs authorities must determine the country of origin, to decide whether the imported product is subject to the MFN duty rate or a preferential rate based on an RTA or PTA. This is usually easy in the case of a raw material, but can be extremely difficult in the case of a manufactured product that includes components produced in more than one country and assembled in another.

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RULES OF ORIGIN

What is the origin of an iPhone assembled in China by a Taiwanese company when all major components (and the intellectual property) come from other countries (the United States, Japan, Korea and Germany), and the assembly cost is only US$6.50, less than 4% of the total manufacturing cost?⁹For duty and other purposes, the United States treats such iPhones as Chinese, applying the so-called “substantial transformation” test, under which a product is treated as originating in the intermediate country if it undergoes “a fundamental change in form, appearance, nature, or character” there.

However, substantial transformation is not the only test that the United States applies in determining origin. In many of its FTAs it uses the so-called “Change of Tariff Heading” (CTH), under which a specified change in tariff classification in the intermediate country confers origin. This approach is used in many regional trade agreements. In other cases, such as its GSP programme, it applies a value-added test, under which the issue is how much value was added to the product in the intermediate country.¹⁰Under the value-added approach, iPhones would not be considered Chinese.

The second step is determining the duty rate from the tariff schedules of the importing country, based on the product classification. Often this is quite straightforward, but it can be difficult where the imported product does not fall within a specific definition. The final step, which is required unless the product is subject to a specific rate, is to determine its value, to which the ad valorem duty rate is applied. Frequently it will be based on the invoiced value, but sometimes this cannot be used, requiring a more complex approach. The three steps are described in more detail in Chapter Three.

3.0 GATT Rules on Tariffs

Tariffs are the only form of general border measure not prohibited by the WTO system, though imports may be barred from entry if they do not comply with applicable intellectual property rules or other relevant domestic regulations, such as those designed to promote health and safety. A WTO Panel said that:

[T]ariffs are the GATT agreement’s border protection ‘of choice’. Quantitative restrictions impose absolute limits on imports, while tariffs do not. In contrast to MFN tariffs, which permit the most efficient competitor to supply imports, quantitative restrictions usually have a trade distorting effect; their allocation can be problematic and their administration may not be transparent.11

Tariffs also provide revenue for governments, whereas quotas do not unless auctioned by the government. The revenue from tariffs is not so important for developed countries (on average less than 0.5% of GDP), but as noted above is important for some least-developed countries.

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3.1. Tariff Bindings

Once a WTO Member has committed itself in a trade negotiation to particular tariff rates on a product-by-product basis, those rates are “inscribed” in its tariff schedule, which is filed with the WTO.¹²At this point, the tariffs are “bound” to that rate, i.e., a Member cannot increase its tariff above the bound rate without renegotiating its commitments – an extremely rare occurrence.¹³Bindings thus provide business with an important degree of certainty. Developed countries have bound almost all of their rates, as have a number of Latin American countries, but many developing countries have not bound their rates on all products.¹⁴However, under the WTO Agreement on Agriculture, all Members have bound their tariff rates on agricultural products.¹⁵

3.2 No Limits on Tariffs

The GATT does not impose any limit on the maximum tariff that a Member may impose on imports so long as it is within the bound rate.¹⁶However, the system encourages countries to reduce their tariff rates on a reciprocal basis in multilateral trade negotiations. The greatest success of the GATT system was the enormous reduction in tariff rates through eight rounds of trade negotiations, beginning with the negotiation of the GATT agreement in 1947 and ending with the Uruguay Round which gave birth to the WTO. The weighted average tariff imposed by the United States is now only 2.2%,¹⁷although US tariffs are still a good deal higher on some products, particularly in the areas of textiles and clothing, and some agricultural goods.

3.3 Applied Tariff Rates

A country may impose an actual duty – known as the “applied rate” – that is below its bound, or “ceiling”, rate. Many developing countries do so as a result of having lowered their tariffs on a unilateral basis.¹⁸This practice gives developing countries flexibility to raise their tariffs up to the bound rate in the future in order to protect domestic business interests. The possibility that a developing country will increase its tariffs to the bound rate also creates uncertainty for foreign business interests seeking to export goods to the country in question and may therefore provide some additional level of “psychological” protection. The bound rates of many Latin American countries are often several times higher than their applied rates, as shown by the following examples:¹⁹

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Where a domestic industry is facing severe competition from imports, it should determine whether the applied tariff rate is below the bound rate. If it is, it may wish to lobby its government to raise the applicable tariff to the bound rate. Conversely, where an exporter faces a sudden increase in the tariff imposed by an importing country, it should check to determine whether the new rate is still within the bound rate recorded in the Member’s tariff schedule (in which case the tariff cannot be successfully challenged in the WTO) before trying to persuade its government to challenge the action.

Businesses seeking to invest in a Member country as a means of gaining easier access to its market should examine, among other elements, both the Member’s applied and bound rates on relevant products before making an investment decision.20

3.4 Exceptions to Article II

Under Article II:2, bindings do not apply to internal taxes, such as an excise tax, which may be applied to imports and collected at the border so long as the rate is not higher than that levied on like domestic products. They also do not apply to antidumping or countervailing duties,²¹or to fees or other charges “commensurate with the services provided.”

4.0 Tariffs Under Regional Trade Agreements and Preferential Trade Arrangements

4.1 Regional Trade Agreements (RTAs)

As noted in Chapter One, when an RTA enters force, WTO rules do not require the parties to an RTA to remove tariffs on all goods from the other parties, but only on “substantially all of the trade” between the parties.²²There is no definition of “substantially all” in the WTO Agreements, and the only attempt by the WTO Appellate Body to clarify the term was the rather unhelpful comment that it means “considerably more than merely some” but not as much as “all” of the trade.²³However, it is generally considered that elimination of duties at least 85% of trade will satisfy the “substantially all” test. But there is no agreement as to whether the percentage applies to tariff lines or to volume of trade. If the former, a large volume of trade can be excluded, and in fact many RTAs, particularly in Asia, exclude large amounts of agricultural trade. Businesses should therefore undertake thorough research as to the present and likely future coverage of an RTA when basing trade and investment decisions on the existence of an RTA.

Second, Article XXIV requires elimination of duties “within a reasonable period of time”, which was defined in an Understanding adopted during the Uruguay Round as 10 years save in exceptional circumstances.²⁴ A common procedure is for the tariffs to be reduced and eventually removed in four tranches. Upon entry into force of the agreement tariffs are removed immediately on the least sensitive products and reduced on the others, followed by two intermediate tranches with further reduction/ removal, and after 10 years removal of tariffs on all remaining products save for those excluded from the agreement or that are (exceptionally) subject to a longer phase-out.

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A business facing a tariff on a product being traded between countries that are parties to an RTA should determine whether: (a) the product has been excluded from the RTA, or (b) it is still in the “phase-out” stage of the RTA. If neither situation applies, it may be able to work through a Member government to challenge the tariff.

4.2 Preferential Trade Arrangements

As explained in Chapter One, preferential arrangements, under which developed countries give one-way tariff preferences to imports from developing countries are authorised by the Enabling Clause but not required by it. Thus, each country giving such preferences can do so in any way that it wishes. It can exclude particular products, and it may choose to exclude certain categories of countries from the preferences, though it must give equal treatment to similarly situated countries.²⁵

Because preferential arrangements are voluntary, developed countries offering preferences are free to change their programmes without reference to the recipients of the benefits or to other WTO Members. Sometimes this happens when domestic industries feel threatened by the increase of imports from countries accorded preferences.

4.2.1 The US GSP Programme

Under its GSP emes, the United States provides duty-free entry to specified goods (but not items that are deemed to be “import-sensitive”, such as textiles and footwear) from specified developing countries, while excluding countries based on various criteria, such as failure to provide core labour rights, aiding or abetting international terrorism, or failure to recognise US intellectual property rights. Leastdeveloped countries receive duty-free treatment on a wider range of products. Countries are “graduated” from the programme when their GDP exceeds a specified level. The Office of the US Trade Representative reviews the programme every year to decide which countries and products should be taken off or put back on the eligibility list.

A major problem with the US GSP programme is that Congress only authorises it for short periods of time (often only two years), and frequently allows the programme to lapse for some time.²⁶This creates great uncertainty for exporters and importers, who do not know whether duties will be imposed on imports made during the hiatus, either because Congress fails to renew the programme, or because it does not make renewal retroactive.

4.2.2 The EU GSP Programme

Under the basic EU programme tariffs are reduced, but not necessarily removed, on a range of products. Under its enhanced, or GSP+ programme, duties are completely removed on the same products when imported from countries that ratify and implement international conventions relating to human and labour rights, environment and good governance. The EU graduates countries from its GSP and GSP+ programmes when their performance in the EU market exceeds a specified threshold over a three-year period. Under the EU Everything But Arms programme, almost all imports from least-developed countries enter duty free and quota free.

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4.2.3 Regional Preference Programmes

Some developed countries also provide preferences to developing countries on a regional basis. Examples include the US Caribbean Basin Initiative (CBI) and the African Growth and Opportunity Act (AGOA), and the EU programme granting preferences under the Lomé Agreements and the Cotonou Convention to former colonies in Africa, the Caribbean and the Pacific.²⁷ These programmes generally cover a wider range of products than GSP programmes. The CBI and AGOA also provide greater assurance to exporters and importers than the US GSP programme as they are authorised for longer time periods.²⁸Because the Enabling Clause does not authorise regional preference programmes, they require waivers by the WTO’s Members from the MFN requirement.

Smart businesses have begun to realise that preference programmes can be used to shape investment decisions. For example, BMW greatly expanded its South African facilities to take advantage of AGOA (as well as EU preferences), and now exports cars worth well over US$1 billion a year to the United States.29 Some Taiwanese textile firms have located clothing manufacturing plants in African countries in order to gain easier access to the US market pursuant to the terms of the US GSP programme and AGOA. Businesses seeking to take advantage of preference programmes should carefully study the terms of such schemes.

5.0 The Ban on Quantitative Restrictions

5.1 The General Rule

Article XI:1 of the GATT provides that “no prohibitions or restrictions other than duties, taxes or other charges, whether made effective through quotas, import or export licenses or other measures” may be imposed by any Member on imports from or exports to other Members. Article XI has been applied to invalidate a wide range of government actions affecting imports and exports beyond simple quotas. For example, trade balancing and foreign exchange balancing requirements would fall foul of Article XI, and the Agreement on Trade Related Investment Measures (TRIMs). The TRIMs Agreement is not discussed in detail in this book because it adds few if any substantive obligations beyond those imposed by GATT Articles III and XI.³⁰

As an illustration of the breadth of its reach, in an early case a GATT panel held that “administrative guidance” by the Japanese Government suggesting that semiconductor companies not export at prices below their costs was inconsistent with Article XI. In the Panel’s view, the Japanese Government had created an administrative structure that operated to exert maximum pressure on the manufacturers not to export below cost. The fact that the measures might not be legally binding was a matter of form rather than substance, because the “administrative guidance” was effectively mandatory.³¹In other cases decided by the GATT and the WTO, measures such as minimum import and export price requirements, non-automatic licensing systems, and trade balancing requirements (limiting the value of raw materials and components that a manufacturer may import to the value of its exports) have been held to violate Article XI.³²

While quotas have more often been applied to imports, in order to protect domestic industries, two fairly recent decisions by the WTO Appellate Body found that Chinese restraints on exports of raw materials and of rare earth elements violated Article XI.³³Export restraints are usually designed to lower raw material costs for local industries thereby encouraging local production of value-added products.

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An import ban is treated as an illegal quota under Article XI. An export ban would normally be treated likewise.

Businesses that find that their import or exports are being inhibited by any government action other than tariffs or taxes should bring the matter to the attention of their governments.

5.2 Exceptions to the Rule Against Quotas

Article XI contains a number of exceptions. These include temporary export restrictions designed to relieve critical shortages of food or other essential commodities, and import and export restrictions related to the classification, grading or marketing of commodities. Historically, Article XI:2(c), by far the most important exception, allowed restrictions to be placed on imports of agricultural or fisheries products that were necessary for the enforcement of various types of government support measures, such as government purchases of excess production and marketing restrictions.³⁴ Many countries imposed quotas on agricultural imports under this exception. However, under the Uruguay Round Agreement on Agriculture, Members had to replace all quotas and other non-tariff restrictions on agricultural imports with tariffs.³⁵This exception is therefore no longer applicable, at least to agricultural products, although it still applies to fisheries products.³⁶

5.3 Import Licensing

Most countries require importers to obtain government authorisation, in the form of import licenses, in order to import certain products. Import licensing may be benign, for example to collect statistics,³⁷or to ensure that a product whose sale is controlled internally, such as alcohol or firearms, is only imported by an authorised dealer.³⁸Another legitimate purpose of import licensing systems is to allocate imports between supplying countries and among importers where a quota system is in place. Import quotas placing an absolute limit on imports are very rare since they are generally outlawed by the WTO Agreements. However, as discussed in Chapter Seven, tariffrate quotas (TRQs) are quite widespread on agricultural products. To avoid a “firstcome, first-served” free-for-all at the border, import licenses are frequently used to allocate the in-quota amount, which obviously has value, to supplying countries and to importers.

Import licensing systems are also sometimes used as a means of unjustifiably restricting imports, and in a number of WTO cases such systems have been held to violate Article XI or other GATT provisions.

LICENSING SYSTEMS INCONSISTENT WITH GATT

• An EC licensing system for banana imports was found to violate Article I (MFN) because it favoured certain countries over others.³⁹
• India used an import licensing system to restrict imports of thousands of items. A WTO panel decision, upheld by the Appellate Body, found that this violated GATT Article XI and could not be justified under the balance-ofpayment provision of Article XVIII.⁴⁰

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5.3.1 The Agreement on Import Licensing Procedures

The WTO Agreement on Import Licensing Procedures (AILP), which occupies only six pages of text, is one of the shortest and least controversial agreements to come out of the Uruguay Round. It sets forth procedural rules governing import licensing, and is designed to ensure smooth operation of import licensing systems, and to prevent their abuse. The Agreement sets forth some general principles, such as transparency, applicable to all licensing programmes, then provides more detailed procedural rules governing automatic and non-automatic licensing systems.

Automatic licensing is usually aimed at collecting statistics, or enforcing regulations concerning products such as explosives, firearms, tobacco and alcohol, designed to ensure that imports are only made by authorised dealers. As the name implies, issuance of the license is automatic so long as the importer meets the necessary qualifications, and there is generally no limit on the quantity of goods that can be imported. The AILP requires automatic licenses to be issued immediately if possible, and in any case in no more than 10 days.

Non-automatic licensing implies a degree of discretion on the part of the government in granting an import license, which of course creates the opportunity for abuse. This type of import licensing is most commonly found in the case of TRQs, which are frequently applied to agricultural imports. The AILP requires that details of the system must be published. License validity should be of reasonable duration and not too short to preclude imports. In allocating licenses, Members should consider past performance of suppliers (i.e., a supplier that has not filled its allocation for a past period may lose part of it for the future), and Members should consider giving licenses to new suppliers.

5.3.2 Challenging an Import Licensing System
Only procedural issues can be challenged under the AILP. Where a licensing system is discriminatory or unjustifiably restricts imports, then the challenge must be under the relevant substantive provision of the GATT (e.g., Article XI) or another WTO Agreement.

A business whose products are subject to a licensing system should pay careful attention to the way in which it is being applied. If the procedures required by the AILP are not followed, a complaint to the licensing authority may be enough to cure the problem. But where a licensing system is being used to restrict imports or to favour imports from other sources, it may be necessary to request the government of the exporting country to take up the issue on a bilateral basis.

6.0 The Rules Against Discrimination

Non-discrimination is a cornerstone principle of the international trading system. After World War I, the belief developed in the United States that one of the major causes of the war had been trade discrimination:

Closed trade areas controlled by Imperial powers were held to deny other countries their natural rights to vital raw materials, markets, and investment outlets. The excluded countries, so the argument ran, not only felt aggrieved as a result of such discrimination; they were driven to obtain by force what they would otherwise have obtained by peaceful exchange.41

Accordingly, one of President Wilson’s Fourteen Points called for “the removal, so far as possible, of all economic barriers and the establishment of an equality of trade[Page53:]conditions among all the nations consenting to the peace and associating themselves for its maintenance.”⁴²

Congressman Cordell Hull, later President Franklin Roosevelt’s Secretary of State and one of the principal architects of the modern trading system, once stated that unfair and discriminatory trade arrangements “almost inevitably resulted in international quarrels, the arousing of the war spirit, increased armaments, militarism, and, ultimately, war.”⁴³As noted earlier, Hull’s beliefs were borne out some years later by the Japanese attack on Pearl Harbor, which was prompted at least in part by a US embargo on sales of oil and other products to Japan.⁴⁴The negotiators of the International Trade Organization and the GATT placed non-discrimination at the forefront of their objectives.

GATT rules prohibit discrimination between imports from different sources (the MFN principle) and discrimination against imports in favour of domestic products (the National Treatment principle). Before addressing these two components of the non-discrimination principle, we discuss the term “like product”, which is critical to the application of the non-discrimination principle in the GATT and other WTO Agreements.

6.1 Like Product

The concept of a “like” product is one of the key GATT terms, and is used many times in the GATT Agreement,⁴⁵most importantly in Articles I and III, dealing with MFN and National Treatment respectively. For example, Article I bans discrimination between imports of “like products” from different countries. The term is also used in many of the specialised WTO Agreements, such as the Anti-dumping Agreement and the Agreement on Subsidies and Countervailing Measures.

The like product issue is often a determinative one in Article I and Article III cases, and is decided on a case-by-case basis. In the seminal like product case, Spain – Unroasted Coffee,⁴⁶a GATT panel held that different varieties of coffee constituted a single like product. In the Japan – Alcoholic Beverages case,⁴⁷discussed below, the Appellate Body identified four factors that are relevant in determining the like product issue: product properties, end-uses, consumer tastes and habits, and tariff classification. In EC – Asbestos the AB held that health risk was also a factor that could be taken into account within the criteria of physical properties and consumer tastes and habits.⁴⁸

Businesses faced with what they think may be discrimination should first evaluate whether the products in question are like products. Under the MFN principle, if two imported products from different Members are like products, the importing Member must treat them the same for tax and regulatory purposes. Under the National Treatment principle, if an imported and domestic product are like products, the imported product cannot be treated less favourably for tax or regulatory purposes. Both the National Treatment and MFN rules are subject to exceptions that are discussed in Section 8.0.

6.2 The Most-Favoured Nation Principle (MFN)

6.2.1 The General Rule

The MFN principle, set forth in Article I of the GATT, requires that “like products” imported from or exported⁴⁹ to any WTO Member be given identical treatment with respect to customs duties, rules and formalities connected with importing and exporting, and internal taxes and regulations. The MFN principle has been described by the Appellate Body as “a cornerstone of the GATT and … one of the pillars of the WTO trading system.”⁵⁰Nevertheless, as explained below, there are major exceptions to the rule.

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There have not been many cases involving Article I, perhaps because countries generally have less incentive to discriminate against imports from different Members than to discriminate against imports in favour of domestic products. One of the most egregious examples of an Article I violation was a law passed by the US Congress in 2007 denying funding for the inspection and certification of Chinese poultry in order to determine whether it met US health standards, thus making it impossible for Chinese poultry to be exported to the United States. A WTO panel had little difficulty finding that the law violated Article I because there were no funding restrictions with respect to other countries.⁵¹

6.2.2 Exceptions to the MFN Rule

There are two major exceptions to the MFN rule:

1. Article XXIV permits WTO Members to form regional trade agreements (free-trade areas and customs unions), in which the Members eliminate duties to imports from each other, while maintaining duties on imports from other countries.
2. Developed countries are allowed to provide “unilateral” tariff concessions on imports from developing countries under the Generalised System of Preferences.

Both arrangements are discussed in more detail in Chapter One. There has been an enormous growth in trade covered by these two types of arrangement, which together cover well over half of total world trade. This figure will grow if regional trade agreements such as the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP) eventually enter into effect.

Businesses should factor in the likely financial effects that agreements due for ratification or still under negotiation, such as the TPP and the TTIP, may have for their activities and consider how best to take advantage of these agreements (as well as the potential financial risks to their businesses that may result from these agreements). However, at the time of writing (April 2017) it was by no means clear whether either Agreement would go into effect. President Trump withdrew the United States from TPP in January 2017, though the 11 other signatories are discussing whether to ratify the agreement. In addition, TTIP has been running into serious opposition in Europe. Businesses with activities in Asia and Africa should also pay close attention to the progress of the Regional Comprehensive Economic Partnership (the 10 ASEAN members plus Australia, China, India, Japan, Korea and New Zealand), and the Tripartite Agreement (28 African countries), both currently under negotiation.

6.3 National Treatment

6.3.1 Introduction

While many of the GATT rules, such as MFN, tariff bindings and the ban on quotas apply at the border, the rules do not stop there. One of the most important (and mostlitigated) GATT provisions, Article III, requires that imported goods be given “national treatment” once they have crossed the border and entered the commerce of the importing country. National treatment means that the goods in question must be treated at least as well as their domestic counterparts with respect to internal taxes and regulations. The WTO Appellate Body has said that Article III is designed “to provide equality of competitive conditions for imported products in relation to domestic products.”⁵²Article III provides a powerful weapon against the tendency of governments, often as a result of political pressure, to favour domestic products over imports.

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Paragraph 1 of Article III sets out the general framework, declaring that internal taxes and other measures should not be applied to imported or domestic goods “so as to afford protection to domestic production.” Subsequent paragraphs lay down detailed rules applying to specific situations. The most important of these rules are found in Paragraphs 2 and 4, dealing with taxes and other measures (usually regulations) respectively.

6.3.2 Internal Taxes

Paragraph 2 of Article III forbids the application of internal taxes to imported products that are higher than those applied to domestic “like products”. It also applies to “directly competitive or substitutable” goods, but in this case minor tax differences that would not affect trade are allowed.

Tax regimes imposed by various countries that discriminated in favour of domestically produced spirits were successfully challenged under Article III in a number of WTO cases.⁵³The first of these involved a Japanese excise tax on shochu, a distilled spirit produced in Japan, that was taxed much lower than other distilled spirits, such as whiskey, gin, brandy and vodka, most of which were imported. The Appellate Body determined that shochu and vodka are like products, and that shochu and other spirits, including gin, brandy and whiskey, are directly competitive or substitutable products. As a result of the decision, Japan eliminated the tax discrimination between shochu and other alcoholic beverages such as vodka, gin, rum, whiskey, and brandy.⁵⁴Consequently imports of spirits into Japan increased by nearly 40% over the next five years.⁵⁵Subsequent decisions invalidated similar schemes instituted by Korea, Chile and the Philippines. At the time of writing, the EU was close to settling a similar dispute with Colombia which had proceeded to the panel stage of WTO dispute settlement.⁵⁶In each case, European and US spirits manufacturers pushed their governments to act on their behalf. WTO cases involving the alcoholic beverage industry are discussed in more detail in Chapter Thirteen, Case Study B.

A business whose exports are facing a higher internal tax than competing domestic products should consider requesting its government to mount a challenge. It is important to understand that it is not necessary that the tax be specifically directed at imports, provided that it has a disproportionate effect on imports. In the Chile – Alcoholic Beverages case, for example a key fact was that although the tax appeared neutral on its face, in that a product of a given strength paid the same rate whether imported or domestically made, in practice (probably by design) most Chilean products paid the lowest tax rate, and most imported products the highest rate, which was nearly twice as high as the rate applicable to Chilean products.

6.3.3 Other Measures (Regulations)

Article III:4 of the GATT provides that imports from any WTO Member shall be treated no less favourably than domestic “like products” with respect to “all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use.”⁵⁷From the business perspective, the national treatment rule as applied to laws and regulations is a powerful and broad-ranging provision, and has been the subject of a great deal of business-inspired litigation in the GATT and the WTO. For example, in the first case decided in the WTO dispute settlement system, Brazil and Venezuela successfully challenged a US regulation designed to reduce automobile exhaust emissions that discriminated in favour of US refiners.⁵⁸After the decision, the United States modified its regulations to end the discriminatory treatment.

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Increasingly non-discrimination cases involve rules that appear originneutral but accord an advantage to certain producers over others (de facto discrimination). Business should not just study the text of a measure to ascertain a discriminatory effect, they should also analyse whether the measure in practice results in an “advantage” being accorded certain producers over others, even though the measure on its face appears non-discriminatory. Economic data can be used to prove a case of de facto discrimination.

EXAMPLES OF ARTICLE III CASES

The broad reach of Article III is illustrated by the following examples of laws and regulations that have been held to be inconsistent with Article III:

• The provision of low-interest loans to Italian farmers who bought Italian tractors, but not to Italian farmers who bought imported tractors.⁵⁹
• A law allowing challenges to imported products alleged to infringe US intellectual property rights to be brought before a special agency rather than US courts. This was found to be discriminatory, in part because the extremely short mandatory time limits in such a proceeding allowed a foreign defendant much less time to prepare its case than a domestic infringer sued in a US court, where the time limits were less strict.⁶⁰
• A Canadian law imposing minimum prices on beer. Although the minimum prices were the same for imported as for domestic beer, the restriction was found to deny US beer equal conditions of competition by preventing US beer from underselling Canadian beer.⁶¹
• A Korean requirement that imported beef be sold in separate stores from domestic beef, or in separate areas in large stores, resulting in far fewer retail outlets for imported beef.⁶²
• Chinese measures limiting the distribution of certain imported reading materials to wholly Chinese-owned enterprises.⁶³
• Stricter VAT reporting requirements for imported cigarettes than for locally produced cigarettes.⁶⁴

Companies should pay attention to situations in which their exports are being treated less favourably in any respect than a competing like domestic product. They should look for differences in tax and regulatory treatment.

Business should take note that most local content requirements65 are likely to violate Article III, since they deprive foreign exporters, and local importers of raw materials and components, of the opportunity to compete for the proportion of the manufacturer’s requirements that are reserved for domestic sources. Local content requirements also are likely to violate the Agreement on Trade-Related Investment Measures.66 Businesses should contact their governments if they believe that foreign local content requirements are resulting in discrimination against their products, including inputs and machinery required to produce foreign products.

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6.3.4 Government Procurement

Paragraph 8(a) of Article III exempts government procurement from the national treatment requirement, so that governments may discriminate in favour of domestic producers where they are purchasing goods for their own use, although not where they are buying goods for resale, or for the production of goods for sale. Many governments discriminate against foreign sources when soliciting bids for the supply of goods or services. Some will not entertain foreign bids at all, or erect procedural hurdles that are difficult or impossible for foreign bidders to overcome. The US procurement system does not discriminate against foreign bids in these ways, but under the US Buy-American Act a foreign bid must generally be more than 6% below the lowest domestic bid (or 12% if the lowest domestic bidder is a small business) to be considered price-competitive. The differential is 50% in the case of military procurement.

The Government Procurement Agreement (GPA), negotiated during the Uruguay Round, requires national treatment, i.e., non-discrimination, in the case of government procurement by designated government agencies, but is only binding on those Members that have signed it, most of whom are developed countries. Also, some free trade agreements, including all US FTAs, require each party to give national treatment in procurement by specified government agencies to suppliers from the other signatory(s). The GPA is discussed in Chapter Eight.

A company seeking to tender for a domestic or foreign government contract should first ascertain whether its government has signed the GPA or a regional trade agreement with commitments covering government procurement, and whether the contract in question is covered by a signatory’s commitments under such an agreement. The commitments – specifying the agencies whose procurement is subject to the GPA – can be found on the WTO website.67 If a company suspects a violation, it should request its government to take up the matter with the other signatory.

7.0 Transparency

In Section 6.0 of Chapter One, we set out websites where the business community and civil society can find important trade-related information. Here we discuss why WTO Members make this information available and how it is collected.

It is difficult for a business to engage in international trade without knowing the “rules of the game”. For example, a coffee grower in Kenya who is planning to sell coffee to Europe needs to know what the applicable duty will be and whether there are other restrictions on imports, such as tariff-rate quotas, what measures are in place to ensure that the imported coffee is wholesome, and, if the coffee is to be sold in consumer packages, the applicable packaging and labelling requirements. Transparency is one of the cornerstone principles of the WTO system, which imposes three types of transparency obligations on its Members.

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7.1 Publication

Article X of the GATT requires each WTO Member to publish promptly all laws and regulations, as well as “judicial decisions and administrative rulings of general application”, relating to customs issues (such as duty rates, valuation and classification issues, and quantitative restrictions), as well as those relating to the sale or distribution of imports or exports. Each of the specialised WTO Agreements contains similar requirements.

Most countries publish their trade related laws and regulations in an official journal or similar publication. Examples include the Federal Register (United States), the Official Journal of the European Union, and the Diario Oficial (Mexico).

7.2 Notification and Comment

Some of the WTO Agreements also require Members to notify the other Members, through the Secretariat, of certain actions or proposed actions.⁶⁸For example, the Agreement on Technical Barriers to Trade (TBT) and the Agreement on Sanitary and Phytosanitary Measures (SPS) contain notification requirements,⁶⁹and it is possible to search the WTO website for particular notifications, by Member and/or by product area.⁷⁰The record of notifications is however patchy in the case of some developing countries.

7.3 Enquiry Points

The TBT and SPS Agreements, as well as the GATS and the TRIPS Agreement, require each Member to establish enquiry or contact points to answer reasonable enquiries from Members and, in the case of the TBT Agreement, from interested parties in other Members. The contact details of the enquiry and contact points established under the different agreements can be found on the WTO website.⁷¹

8.0 GATT Exceptions

8.1 Article XX General Exceptions

Article XX of the GATT contains general exceptions to GATT rules which Members have invoked in dispute settlement with limited success. The most important exceptions exempt measures:

• “Necessary” to protect public morals;
• “Necessary” for the protection of human, animal or plant life or health;
• “Necessary” for compliance with laws and regulations not inconsistent with the GATT; and
• Measures related to the conservation of exhaustible natural resources.⁷²

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To be justified under Article XX, a Member’s trade measure must not only fall within one of the above exceptions, it must also pass muster under the introductory paragraph, known as the “chapeau”, described in Section 8.1.1 below. In most of the recent cases involving an Article XX exception panels and/or the Appellate Body have found that the terms of the specific exceptions were met, and instead undertook an in-depth analysis of the chapeau. In only two cases involving Article XX, discussed in the text box in Section 8.1.1, has the Appellate Body found that the Respondent [the Member relying on the Article XX exception] satisfied the conditions of the chapeau).

The business community should be aware that, when dealing with multiple claims, WTO panels and the Appellate Body examine the most specific WTO Agreement first. This means that outside of cases involving tax matters and quantitative restrictions, in recent years WTO tribunals have issued fewer decisions involving the GATT in general and Article XX in particular. Instead tribunals are reaching decisions based on more specific WTO Agreements, such as the TBT and SPS Agreements which, like Articles I and III GATT, deal with regulatory matters. Nevertheless, cases interpreting Article XX GATT are important for understanding the GATS, TBT and SPS Agreements, and other WTO Agreements, as they often use the same language.

8.1.1 Article XX’s Chapeau

Article XX’s chapeau requires that Article XX exceptions may not be applied “in a manner which would constitute a means of arbitrary or unjustifiable discrimination between countries where the same conditions prevail, or a disguised restriction on international trade”. The chapeau deals with how a Member applies a trade measure predicated on one of the general exceptions; its purpose is to prevent abuse of these exceptions. The chapeau requires that a Member exercise Article XX exceptions “reasonably” and in “good faith” and in order to protect the “legitimate interests” set forth in the Article XX exceptions.

In a number of cases the Appellate Body found that the conditions of the chapeau had not been met because the measure at issue had been applied in a discriminatory fashion. Other cases have looked at the rationale for the measure itself (its “design, architecture and revealing structure”)⁷³and determined whether the measure achieves its stated goals. Other cases (discussed below) have looked at whether the Member sought to find a cooperative solution to address a matter covered by an exception, and whether a Member adopted a flexible approach to the application of its trade measure (accepting different solutions from Members that achieved an comparable level of protection).

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CASES CONSIDERING THE CHAPEAU

US – Shrimp⁷⁴ considered a ban by the United States of imports of shrimp from shrimp boats not equipped with a special device that allowed sea turtles (an endangered species) to escape from shrimp nets. The Appellate Body found that the US measure was related to the conservation of an exhaustible natural resource. The Appellate Body also found that the US measure failed to meet the requirements of Article XX’s chapeau as the United States had not applied its measure in a flexible manner or sought a cooperative solution with all relevant Members, and had discriminated against some Members where the same conditions prevail. In a subsequent phase of the case, US – Shrimp (Article 21.5), the United States successfully justified its trade measure, a ban on Malaysian shrimp imports, under the chapeau, on the grounds that the United States had made a good faith effort to seek a multilateral/ cooperative solution with Malaysia to protect sea turtles killed in conjunction with Malaysian shrimp harvests.⁷⁵

In EC – Asbestos the EC successfully justified its trade measure under the chapeau to prohibit all imports of asbestos and asbestos-containing products (known carcinogens that pose a risk to human health). The Panel found that there was no discrimination associated with the EC measure and that the EC measure did not have protectionist objectives.⁷⁶

In EU – Seal Products⁷⁷the WTO Appellate Body recognised that an EU ban on the importation of seal products was “necessary to protect public morals”; reasoning that animal welfare concerns were questions of public morality. The Appellate Body found however that the ban failed to meet the requirements of the chapeau since exceptions to the ban were applied more favourably to Greenland than to Norway and Canada.

8.2 Security Exceptions

Article XXI(b) of the GATT allows WTO Members to take actions in violation of the GATT that it considers necessary for the protection of its essential security interests: (i) relating to fissionable materials (or the materials from which they are derived); (ii) relating to traffic in arms, ammunition and implements of war and other goods that can be used for military purposes; and (iii) taken in time of war or other emergency in international relations. Article XXI(c) allows Members to take action (such as the imposition of sanctions) required under the UN Charter.

Article XXI has rarely been relied upon to justify actions that would otherwise violate the GATT. One well-known case, involved a challenge to the Helms-Burton Act,⁷⁸a US law permitting legal action in the US court system against foreign companies that had “trafficked” in property that had belonged to US citizens but had been expropriated under the Castro regime. The United States took the position that a WTO panel had no right to rule upon actions taken under Article XXI(b) because the term “it considers necessary” gave the country invoking that provision the unreviewable right to take any action it chose. One US official was quoted as saying: “We would not show up [to the panel proceedings]. This is a matter that touches on the foreign policy and national security of the United States, as to which no panel in the WTO is competent.”⁷⁹Fortunately, the case settled before the panel issued a ruling. Had the Panel and Appellate Body agreed with the United States, a huge opportunity for evasion of GATT/WTO obligations would have opened. On the other hand, a ruling against the United States would have added a great deal of fuel to the anti-WTO sentiments in the US Congress.

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As noted in the Postscript (page 28), in early 2017 the United States launched investigations to determine whether imports of steel and aluminium are threatening US national security. Any import restriction imposed as a result of these investigations will undoubtedly be challenged in the WTO, and the United States may again take the position that its actions cannot be adjudicated in the WTO.

8.3 Balance-of-Payments Exceptions

Under Article XII of the GATT, a WTO Member may impose quantitative restrictions or increased tariffs “in order to safeguard its external financial position and its balance of payments.” The restrictions may not be more than necessary to forestall the imminent threat of, or to stop, a serious decline in monetary reserves, or in the case of a Member with very low monetary reserves, to achieve a reasonable rate of increase in its reserves.⁸⁰The restrictions are to be progressively relaxed as conditions improve, and must be eliminated once conditions no longer justify their imposition.⁸¹Article XVIII of the GATT gives slightly more leeway to developing countries to impose restrictions to protect their balance of payments.

INDIA – QUANTITATIVE RESTRICTIONS82

In India – Quantitative Restrictions the Appellate Body upheld the Panel’s rejection of India’s argument that its import restrictions were justified under the balance-of-payments exception, based on the fact that India had foreign reserves of US$25 billion.

The WTO Agreements contains an “Understanding” that requires Members to provide a schedule for the removal of balance-of-payments restrictions, contains strict notification requirements, gives preference to balance-of-payments measures with the least disruptive trade effects, i.e., price-based measures over quotas (import surcharges and import deposits requirements), and limits Members from applying more than one type of restriction to the same product. The Understanding also limits balance-ofpayments measures to what is necessary to address a particular situation and requires transparency in the application of restrictions. The Understanding is subject to the WTO Dispute Settlement Understanding which is discussed in Chapter 12.⁸³

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