Confronting the challenges of international business disputes

Many challenges may be posed by international business transactions in the form of disputes and litigation arising out of international sales contracts. The factors that disturb the attorneys are the following:

(a) Choice of Forum; (b) Jurisdiction; (c) Service of Process; (d) Forum Non-Conveniens; (e) Parallel Proceedings; (f) Choice of Law; (g) Discovery Rules; (h) Enforcement of Judgments; and (i) Issues involving litigation against Foreign Sovereigns.

When a conflict or dispute arises, the first thing to determine is which is the appropriate forum having jurisdiction to settle the dispute - usually the prudent parties settle this issue by incorporating a clause in the contract by authorizing a specific forum to hear the disputes. International business contracts include a forum selection clause; a typical one might read as under:

"All suits arising out of or relating to the subject matter of this contract Shall be decided solely and exclusively by the courts of the city of London" One has to be careful while distinguishing between mandatory and permissive selections. The clause quoted above is mandatory as it requires to approach the courts of London for settlement of the dispute if arises, whereas a permissive clause would allow but not require litigation in London courts. A better way is to draft a clause broadly to include disputes relating to their contractual relationship, to include not just breach of contract claims but also related tort claims. And where such choices are not made then uncertainty looms.

The forum selection clause is now generally accepted by the municipal courts. In the light of Bremen and Carnival cruise cases, which were decided by the US Supreme Court, the US courts recognize this practice generally; similarly the European Union does recognize the forum selection clause. It may however be noted that courts apply foreign law in such cases and not the domestic law and this factor poses more difficulties.

Personal Jurisdiction is a more significant issue in international cases and for its determination there is a two-part test: first whether the defendant has minimum contacts with the jurisdiction and second whether the exercise of personal jurisdiction over the defendant is reasonable according to notions of fair play and substantial justice. (See Worldwide Volkswagen Corp's case).

Plaintiffs in such cases seek to establish either specific or general personal jurisdiction over the defendant. The elements which determine general jurisdiction over the defendant include either extensive contacts or operations in that jurisdiction or in other words a place of residence; however, for a corporation the scene is different. The required element includes the place of incorporation, the place of principal operations and includes conducting extensive business activities at the disputed place. However, for establishing general jurisdiction the recent trends of the courts are only to consider business operations. (In this regard, attention is invited to the case of Goodyear Dunlop Tires Operations).

In order to determine a specific jurisdiction, Plaintiff is required to establish that the harmful conduct of the defendant had a direct connection to the jurisdiction but the disputed acts must be connected to the jurisdiction. For example, In the Asahi Metal Industry Co's case, plaintiff was injured in a motorcycle accident in California, allegedly due to a defective part manufactured in Japan. The manufacturing company had not sold the part in the US nor taken action to cause it to be sold or used in the United States, the court found that there was no specific jurisdiction. However on the basis of negotiation of a contract at a specific place, it is easy to establish specific jurisdiction. For establishing such jurisdiction the contacts of a subsidiary, affiliate or agent are also relevant factors. It may however be noted that lack of personal jurisdiction can be waived, a forum selection clause is generally treated as an implicit consent to personal jurisdiction in the chosen forum, or there may a specific expression of consent to jurisdiction. However, in civil law the said two concepts tend to be fused under the doctrine of judicial competency.

As regards service of process in international disputes, the issue is governed by an international convention namely, The Hague Service Convention and it addresses service of process. So far 65 nations have become party to the convention. The Convention is the exclusive means of serving process in foreign countries. The convention requires each party to establish a central authority to receive requests to carry out service in their territory. The convention also lays down procedural steps that reasonably assure the plaintiff that compliance with convention will greatly reduce the possibility of successful challenge to the service of process or other documents. Where service is to be made in a country that is not party to The Hague Service Convention, the parties have to proceed through a process called rogatory or in other words, through diplomatic requests.

Forum non-conveniens or an incontinent forum doctrine allows courts to decline to decide a case even where they have jurisdiction for seeking more appropriate place for resolution elsewhere. It is generally dependent on case law. The considerations in this regard are: plaintiff's residency, availability of more adequate foreign forum, private and public factors, promises of the defendant; however this consideration is not available in non common law countries.

Sometimes parallel proceedings are initiated in two countries independently; for example, one party might file for damages in one country and the other party may seek rescission, or a declaration that no breach has occurred in a foreign country. In the United States defendant can ask for lis alibi pendents, that is, proceedings pending elsewhere, a court can grant injunction which is known as anti suit injunction, but such motions are granted in very unusual circumstances, but generally there is no presumption against parallel litigation. The EU law, however, does not recognize parallel litigation rule.

The Hague Convention on Taking of Evidence Abroad in Civil or Commercial Matters (Called the Hague Evidence Convention and not to be confused with the Hague Service Convention) is the instrument to manage international discovery. The Convention has been adopted by 58 nations; the convention helps to meet needs of a dispute resolution forum to obtain evidence while not imposing upon foreign entities demands that are excessive under rules of their nations. This convention also requires nations to establish a central authority to process requests. However, countries may decline to honour discovery requests for different reasons.

Choosing an appropriate law applicable to the dispute is an important decision for a court because the outcome may be very different depending on which substantive law the court applies. Parties may agree in their contract about the choice of law. Often the choice of law and appropriate forum clauses are added to the contract to avoid uncertainty. A typical choice of law clause may read as under:

"The rights and duties of the parties arising from or relating to this contract shall be governed solely and exclusively by the laws of the city of London with regard to its conflict of law rules." In the United States, such clauses are permissible to be incorporated under UCC, in the EU applicable regulations also allow broadly unlimited party autonomy (see EC Regulation No. 593/2008, other sets of rules are also available under the auspices of ICC or UN).

Choice of law for international sales of goods transaction has been partly harmonized by the UN Convention on Contracts for the International Sales of Goods (CISG) which provides a single set of substantive rules for international sales transactions within its scope.

As is evident international contracts for sale of goods provide numerous problems for the parties to the contract and that is why the choices regarding forum and law become important. Another issue relates to proving foreign law, and the courts generally rely on the opinion of the experts in this regard.

Another related problem is that of recognition of foreign judgments. There are different rules regarding enforcement of foreign judgments and parties to the contracts must be careful about these problems. In the Commonwealth countries, for example, it may be reciprocal or can be made binding through reciprocal arrangements. However, recent notable trend is that in many areas the states are recognizing the awards and decisions of foreign tribunals and courts by making these arrangements as part of the domestic law. For example, the awards given by ICSID are being recognized as part of the domestic law in many countries. There is also the Hague Convention on Choice of Court Agreements, which requires recognition and enforcement where the parties chose the foreign court by contractual agreement.

There are special issues in litigation relating to Foreign Sovereign. The limitations include act of state doctrine. This doctrine comes into play even in those cases where sovereign may not be a party. However if possible, it is better to obtain waiver of enforcement immunity.

One has to consider alternate remedies available in this regard to avoid complex legal rules. Many different commercial arbitration options are available to parties; these include arbitration under, ICC, ICSID, UNICITRAl and others. These options are cost efficient and easy to handle

(The writer is an advocate and is currently working  with Azimuddin Law Associates Karachi)

Cross jurisdiction disputes in international arbitration

A contract leads to corporate relationships out of which typical disputes arise quite often. It is evident that with the advent of globalization the outreach of businesses has expanded and the role of multinationals stands spread. This expanded role has given rise to international disputes which quite often are concerned with jurisdiction issues.

Where disputes arise in global businesses, the organisations generally opt for arbitration and such an option gives rise to the question of cross national jurisdiction and effectiveness of arbitration as a dispute settlement process. It is now generally believed that majority of the businesses organisations choose arbitration for dispute resolution.

This write-up while putting to one side the cost implications of using international arbitration over litigation, explores the outcomes that international arbitration can offer over litigation, but it is worth remembering that there will still be certain situations resulting in time-consuming and leading to costly litigation, especially matters involving regulators or government.

Let us examine the mover and shaking forces that have led to an explosion and growth in international arbitration? Rise in cross-border disputes has been there due to expanding role of globalization in international businesses. One may find some more nuanced considerations that international arbitration gives rise to that are not just about the cost of litigation. For example, while the issue of legal privilege does not provide for common rules at the international level, the IBA does attempt to provide some structure. These rules are required to be adopted by the parties either in whole or in part as they provide procedural outlay to deal with the matters of evidence in such cases. The process discussed above shows a significant flexibility in the process that is quite opposite to the rigid framework of the court rules.

Arbitration no doubt offers cost-effectiveness and flexibility,two very important factors that have contributed in shaping the growth of the mechanism provided for dispute resolution. Privacy is another significant factor in this regard.

The fact is that international arbitration is considered by majority as an effective way to keep business practices, trade secrets, industrial processes, intellectual property, and proceedings which may lead to possible negative impacts to the businesses. One should not assume that everything in arbitration happens automatically or remains secret or is treated confidential; the existing procedures only confirm that such proceedings can remain private and confidential.

One clear indication of why international arbitration has become such a popular route to dispute is the advantages it provides over traditional methods of dispute resolution. However one may know that how hard it is to enforce a judgment against someone in another jurisdiction. So how does international arbitration fares when it comes to enforcement of agreements?

A little light on the question of enforcement has been provided by the practitioner’s handbook for international arbitration. It may be noted that parties involved in cross-border disputes can request an arbitrariness to incorporate the settlement agreement into an arbitration award known as a ‘consent award’ or ‘award on agreed terms’, or an award explicitly agreed by the parties. For example, an enforcement issue can emerge in a foreign jurisdiction on the basis of breach of contract under the procedures of the New York Convention. This convention fortunately, bears the benefit of more than 1750 precedents involving more than 65 different countries. The list of contracting states who have signed up to the convention is pretty comprehensive and includes all the major economies around the world.

The Convention does contain provision for the subject of enforcement and provides defense mechanism to attempt the enforcement challenge. See article V, which states among other things: “Recognition and enforcement of the award may be refused, at the request of the party against whom it is invoked, only if that party furnishes to the competent authority where the recognition and enforcement is sought, proof that a party was subject to an incapacity or were given improper notice of the appointment of the arbitrator, or the award deals with a difference outside the contemplation of the submissions to arbitration, or the composition of arbitral authority was not as agreed by the parties or the award has not become binding at the time of enforcement, all of which, to my mind represents reasonable grounds to challenge enforcement”.

One knows that for the process of resolution, enforcement is a significant consideration. However, Article V of the New York Convention does not necessarily mean that it is in any way easy for the subject to get an easy enforcement by challenging and defeating enforcement especially where the arbitration has been conducted properly and by agreement. The provisions in Article V are relatively narrow and actually relate to a perfectly sound mode of good governance.

It is now evident that where awards are given with the mutual consent of the parties, the problem of enforcement is very limited and usually awards are enforced automatically. The experience in this regard shows that such arbitration awards are enforced without many problems and in a very limited number of cases the parties confront enforcement problems. The difficulties generally arise where attempts are made to enforce awards relating to damages, and some problems may also arise in encountering and enforcing declaratory and specific performance awards.

What are the advantages of arbitration; these include flexibility, cost-effectiveness, privacy and enforcement through local jurisdictions under the New York Convention.1 There appears to be a broad consensus across the variety of arbitration rules that different jurisdictions provide and now there appears to be an increasingly popular choice among-st growing number of corporations to face and deal with the question of multiple jurisdictions.

The experience in this regard shows that the two most popular jurisdictions for providing international arbitration stand located in London and Paris, but Hong Kong and Singapore are also gaining momentum quite rapidly. This growth of option for dispute resolution through arbitration is gradual and the dispute resolution scene is changing rapidly.

It appears that some of the most hotly debated topics in arbitration do not necessarily represent the most divergent views in this regard. Arbitration is not considered as ‘over-regulated’, and many business have even expressed a need for further regulation of the conduct of specific actors. This is an indication that the arbitral community is apprehensive of further extensive ‘macro-regulation’ but would welcome limited corrective ‘micro-regulation.'”

It is now widely recognized that a proper scrutiny of processes and procedures is needed, but it is unlikely to result in anything outside the scope of individual jurisdictions, it all explains why London continues to top the preferred location for arbitration. It may be noted that vast majority of actors contributing towards the growth of arbitration happen to be lawyers and they are already subject to stringent regulatory controls.

As globalization continues to break down barriers of trade, the dispute resolution which traditionally had been sought inside a particular jurisdiction’s legal system is no longer capable of, or desirable for, resolving disputes for multinational corporations.

As long as the flexibility, cost-effectiveness, privacy and enforcement through local jurisdictions remain the outcome it suits businesses and trade across several jurisdictions. It is evident that these trends will continue to grow and dominate the dispute resolution scene relating to international businesses.

Customs valuation: Role of price list in determination of transaction value

 The customs value of imported goods is  determined mainly for the purposes of applying taxes  and duties. It constitutes the taxable basis for Customs duties. It is also an essential element for compiling trade statistics, monitoring quantitative restrictions, and collecting national taxes.Customs valuation is a customs procedure applied to determine  the customs value of imported goods. If the rate of duty is ad valor-em, the customs value is essential to determine the duty to be paid on an imported goods. The primary basis for valuation is the "Transaction Value" which means the price actually paid or payable for the goods when sold for export to the destined country.

In determining customs value the  price actually paid or payable should be adjusted to include all the costs and services such as royalties, license fees, commission and brokerage, cost of container and packing, tool, mold, engineering and design work, made as a condition of sale of the imported goods by the buyer to the seller or by the buyer to a third party to satisfy an obligation of the seller. Since the assessment is on a CIF basis, the invoice value should be suitably adjusted to include the freight, insurance and handling charges as well.  This concept is based on the Agreement of Interpretation of Article VII of the General Agreement on Tariffs and Trade 1994.(1)The emphasis of the agreement is that the value should be based on the actual value of goods and not on notional value of goods.

However, the implementation of GATT Code has not been uniform and different countries interpret the valuation method according to their own views and whims.For example, in many cases import value is rejected on grounds unknown to the GATT Code. In many cases Customs  administrations forget that all transactions of imported goods are out come of a contractual obligation between the parties, and this obligation has a binding effect unless an element fraud and misrepresentation is detected and proved. It has also been observed that extraneous factors are at times considered for determining the customs values and among such factors is the use of price list as the basis for determining the customs value.

Articles 1 through 7 of the valuation agreement lay down the methods for determination of customs valuation.(2) In fact GATT Code establishes the fundamental rule that the customs value of imported goods is to be the 'transaction value' of goods or in other words it is the price actually paid or payable for the goods on their sale.(3)

A logical thing to understand is that the GATT code does not lay down uniform values of merchandise or uniform duties of merchandise.  Under the Valuation Code, it is logically possible that the customs value of same merchandise can often differ from one shipment to another, at the given same time and given same  place. This fact supports the  uniformity involved which in fact is the uniformity embodied in the system applied. For example, most of the imports are to be valued on the base of price agreed  between buyer and seller, and as a matter of procedure, the invoice price is to be accepted unless the same is mis-declared. It is possible that in some cases the invoice prices may vary widely; if so, the customs values may also vary widely, even though the goods involved in two transactions  may be identical.

   In the light of what has been stated above, the concept of "Transaction Value" in principle is based on business decisions on pricing as the basis of customs value. Only a minimum number of specified adjustments to the price established in the light of the agreement of the parties may possibly be permitted  to arrive at the  Transaction Value. And in this perspective  only a minimum number of grounds are available for departing from the Transaction Value in order to consider and to apply the alternative basis of valuation as provided under Articles 2 to 7 of the GATT valuation Code.

The acceptance of a price agreed between the parties to one transaction means the rejection of the concept that any two shipments of the same product coming from and going to the same place at the same time must have the same dutiable value within the framework of  Transaction Value(4), and each shipment is to be valued according to its own price, whether the prices differs due to the quantity difference, or due to difference in trade levels, or because of the terms of the sales agreements which might have been entered into at different times - or even if one importer gets a lower price simply because he drives a hard bargain or the exporter chooses to favor him. And in return for a lower price for the imported goods to a particular buyer (importer), the seller (exporter) receives any additional payment or other compensation (especially goods or services), then such additional payments or other compensations will qualify as an indirect payment (in cash or kind) and are to be added to the invoice price to arrive at Transaction Value for customs purposes. Similar calculations are required in a barter or counter trade situation if the price of the imported goods being valued is influenced by a service received or by the price paid by the importer or by the exporter in another transaction which is part of the same barter or counter-trade arrangement. In such situations it may not be possible to value these indirect factors on which the import transaction is conditioned, and then it will not be possible to establish a Transaction Value.

The question now arises about the legal status of the transaction value, that is, can the same be rejected on the basis of a  list price. Here one must remember  that agreements of sale constitute a contracts and are binding on the parties except that such contracts suffer from legal infirmities. Where a list price  is the basis for a sale contract  it may attract consideration of being a sale price otherwise it has no relevance for determination of value.  In many instances, customs authorities make no allegation of mis-declaration and despite that reject the price of the goods imported without giving adequate  reasons for rejection.   Often customs administration reject the transaction value on the basis of price list of the seller, but while doing so, customs not only ignores the GATT code's guiding principles, but also act contrary to the legal provisions in this regard. It may be noted,  by proposing that price list is a valid piece of evidence for the rejection of transaction value since their action ab initio is illegal  and a wrong notion.  The action of the customs is erroneous as it  cannot be a reason by itself to reject the transaction value.(5)

 An invoice price, one has to keep in mind, is a consequence of a legal contract, and where such  invoice price is rejected , one is rejecting the contract cause, reasons and plausible evidence.  And decisions of such a nature become challenge-able  before the W.T.O Arbitration Tribunal, and all this may lead to costs and damages.

The grounds hitherto discussed  may also be reviewed  in the light of one's domestic regulations on the subject (6). Because the laws generally provide that the price (value) in a contract of sale may be fixed by the contract and where the contract provides a fixed price the same is generally enforceable and is accepted as the valid price of goods.

(The writer is an Advocate and is currently working  with M/s Azimuddin Law Associates Karachi.)

1. The agreement consists of four parts and three annexes ie, it provides a hierarchy of methodologies, rules on customs valuation, and a committee to oversee the implementation etc.

2. The Agreement creates a strict and detailed hierarchy of valuation methodologies. Articles 1 through 7 of the Agreement define the methods for determination of customs value in a sequential order of application. Article 1 defines the primary method of valuation, which is used whenever the conditions of Article 1 are met. When the conditions of Article 1 are not met, customs value is to be determined by proceeding sequentially through the succeeding Articles to the first Article under which customs value can be determined. Except as provided in Article 4, it is only where the customs value cannot be determined under a particular Article that the provisions of the next Article are to be used. Article 4 provides that upon request of the importer, the application of Articles 5 and 6 will be reversed. However, if the importer does not request that the order be reversed, these Articles will be considered in their natural sequence. If the importer does request that the order be reversed, but customs value cannot be determined under Article 6, customs value will be determined under Article 5, where possible.

3. Transaction value is the appropriate measure of customs value. However, for the application of the new method the condition required state: (a) there are no restrictions on the disposition or use of the goods by their buyer, other than restrictions which are imposed by law, that limit the geographical area in which the goods are sold, or do not substantially affect the value of the products; (b) the sale price is not subject to some condition or consideration for which a value cannot be determined; (c) no part of the proceeds from the subsequent resale of the product accrues to the seller without adjustment to the transaction value; and, perhaps most importantly, (d) the buyer and seller are not related.

Article 15 provides, the rules for determining where persons are related for purposes of the Agreement. That persons will deemed to be related person only if: (a) they are officers or directors of one another's businesses; (b) they are legally recognized business partners; (c) they are employer and employee; (d) any person directly or indirectly owns, controls or holds five percent or more of the outstanding voting stock or shares of both persons; (e) one person directly or indirectly controls the other; (f) both persons are directly or indirectly controlled by a third person; or (g) they are members of the same family.

4. While determining the transaction value, following additions (applicable where same have been paid by the buyer and not already included in the price) are to be made: • commissions and brokerage, other than buying commissions; • the cost of containers (if not a reusable transportation device) and packing; • the value of certain specified types of goods and services supplied by the buyer free of charge or at reduced cost for use in the production or sale of the imported goods (but excluding design and engineering undertaken in the country of importation); • royalties and licence fees related to the goods imported which must be paid as a condition of the export sale; and • the value of any part of the proceeds of resale, disposal or use of the goods that accrues to the seller.

The following items are excluded, and if in the price are to be deducted 'provided that they are distinguished from the price: 

Charges for construction, erection, assembly, maintenance or technical assistance after importation; 

The cost of transport after importation; 

Duties and taxes of the country of importation.

5. Eicher Tractors case decided by the Indian Jurisdiction.

6. The provisions of section 9 of the Sale of Goods Act, 1930.

Role of assists in determining customs valuation

The moot point here is, what is an "assist" which qualifies for addition to the customs valuation. Assist is  an assistance extended by the buyer to its supplier for the production of goods being supplied to the buyer. For example, a shirt requires two yards of cloth which costs Rs 100 per yard, and this cloth is supplied by the buyer to the suppler of goods, this act of supply of cloth to the supplier by the buyer is an assist.  

GATT code of valuation assumes that the value of goods received from the seller should include at least some of these forms of assistance. The addition of value of the assist is made where such value is not already included in the price / value of goods sold , but since the assist was provided to the seller free of charge by the buyer, the seller may not be charging the buyer for it,(1) and the fact thus call for attention to this aspect of the import. Such assists were part of Customs Valuation under BDV, however, the GATT code provisions differ from the former provisions in a number of important respects, and hence the code must be looked with a fresh eye.

As per Article 8.1(b) of the GATT code of valuation,there are five conditions required to be be satisfied before the  addition of assist  to the value of Goods. These conditions include:

a) The goods and services must have been supplied by the buyer free of charge: Note the following points:

-- What matters is that the assist is supplied by the buyer, regardless of where they come from.

-- The buyer does not need to own or make the assist.

-- Here the reduced cost implies that the measure of the amount of assist is the cost to the buyer.

b) The assist must be used in connection with the production or sale for export of the imported goods.

c) The value of assist must not already be included in the price.

d) The value of assist must be apportioned as appropriate to determine the amount properly attributable to the particular goods being valued for Customs purpose.

e) The assist must be of a category listed in the code.2

An assist can be of the following category:

a) Materials, components, parts and similar items incorporated in the imported goods

b) Tools, dies, molds and similar items used in production of the imported goods.

c) Materials consumed in the production of imported goods.

d) Engineering, developments, artwork, design work and plans and sketches undertaken elsewhere than the country of importation.

However, interpretation of this clause differs in different countries. For example, Canada does not consider engineering follow-through, quality control, trouble shooting, routine or periodic alteration as research and development activities.

Now we come to the point that how calculations for assist are to be made? While making calculations of assist, following are the guide lines to be observed:

a) The assist is to be valued at cost to the buyer who furnishes it without addition for profit.

b) Necessary allocations are to be made according to generally accepted accounting principles.

c) Design, etc, will have nominal value.

d) Things like plans after their use must be given a nominal value.

e) The intangible assist must be necessary for the production of the imported goods.3 Supply of quality control and management personnel at no cost to the seller is to be regarded neither as an assist nor as an indirect payment. Similarly, detailed specifications, including various dimensions noted on a drawing of the machine are included in the buyers' order, so as to advise the exporter/manufacturer of what the buyer needs.

Value of the assist is the cost to the importer of purchasing or producing the product.4 The cost of production governs not only if the importer does the work but also if he produces of the assist is related to the importer. No profit to the importer is to be included. Where the assist has been used by the importer before he sends it abroad as an assist, the value of the assist should accordingly be reduced. In case of damage and deterioration, a downward adjustment in its value may be made even if it has not been used. Where assist involves payments in foreign currency the conversion is permissible.5 For the shipping costs, the provisions of code are silent, hence such costs are apparently to be excluded where the same are not included in the purchase price, however, and in such cases parties have to avoid concealment.

Some assists are directly consumed or physically incorporated in the making processes, in such cases, the cost of assist pertaining to particular number of units of the product exported can usually be determined quite easily.

Sometimes, for one reason or another, it is not worth the trouble to apportion the cost of the assist over the many units involved. The value of the assist may be small, or it may take too much effort or argument to arrive at an appointment, or the entire output may be scheduled for importation at or about the same time. In any case where the importer prefers to do so, he is permitted to include the cost of the entire assist on one or a few early shipments (the necessary cost figures may not be ready immediately). The value might be apportioned to the first shipment if the importer wishes to pay duty on the entire value at one time'. Where this method is adopted, it obviously follows that no addition is to be made in respect of the assist on any later shipments, even though the goods still reflect the assist.

(The writer is an advocate and is currently working  with Azimuddin Law Associates Karachi)

1. See Article 8.1 (b) of the code which states that goods and services supplied directly or indirectly by the buyer free of charge or at reduced cost for use in connection with the production and sale for export of the imported goods.

2. Since Article 8.1 (b) applies only to the specified gods and services

3. For example five sketches are furnished to the manufacturer, who chooses and uses one. Only the cost of that one is to be added.

4. Generally procurement, inspection and warehousing costs are excluded from the value of assist.

5. In terms of Article 9

        How Tax Treaties Allow Benefits from Double Taxation

Double tax treaties provide for relieving double taxation; sometimes double taxation relief is extend to tax paid by foreign subsidiaries and other foreign affiliates in terms of economic definition.

In many cases such controls are exercised by legal definition, the reason being, the sphere of influence of economic definition is wide and broad and difficult to specify the precision needed for tax laws. For example, an economic double taxation may occur when tax is levied as earned and again taxed as consumed. And such double taxation relief on VAT or excises taxes are not permitted by states. The question of double taxation thus gains importance both for states and tax-payers. In this background, this article examines how tax treaties allow relief to tax payers from double taxation.

States, levy taxes not only on domestic assets and domestic economic transactions, but also levy taxes on global capital and transactions carried out in other countries. The foreign income or foreign capital of a resident (natural or juridical) is commonly taxed on residence basis.

An item of income or capital may be taxed in two or more states in the same tax period whether or not in the hands of different taxpayers: It occurs when assets are linked to different persons by the domestic law of the states involved, say for example, where the tax law of one state creates a nexus in respect of an item of capital to its legal owners and the tax law of the other state links that item of capital to the person who controls possession or controls economics.1

Where a state taxes a legal entity at its place of residence and another state disregards the legal entity and taxes its income or capital by attributing it to a resident shareholder, the action forms a double taxation.

Forms of Double Taxation: Double taxation is either juridical or economic.

Juridical double taxation

It occurs where states levy taxes not only on domestic assets and domestic economic transaction, but also levy taxes on capital situated and transactions carried out in other countries in relation to a resident taxpayer’s benefit. The foreign income or foreign capital of a resident (natural or juridical) is commonly taxed on residence basis.

Economic double taxation

It is a situation where an item of income or capital is taxed in two or more states in the same tax period, but that income or capital is in the hands of different taxpayers: It occurs where assets are linked to different persons by the domestic law of the states involved, say for example, where the tax law of one state creates a nexus in respect of an item of capital to its legal owners and the tax law of the other state links that item of capital to the person who controls possession or has an economic benefit.2 Economic double taxation can arise,
_ _ _ _ _ ____________________________
1. Azeem, Zafar: Concept of Nexus in International Taxation: Development of New Horizons in Vodafone’s Case: Pakistan Tax and Corporate Laws Journal: 2011(Journal, 291) 
2. See n.1.
for example if alimony received by a wife from his husband is considered income and is taxed and her hand is not allowed deduction in respect of same payment as an expense in his state of residence or if one state taxes a legal entity at its place of residence whereas another state disregards the legal entity and taxes its income or capital by attributing it to a resident shareholder.

Economic double taxation, like juridical double taxation, can be prevented by domestic laws. Economic double taxation arises due to variance in the rules regarding the inclusion or deduction of positive and negative elements of income and capital, say for example, in cases of transfer pricing. The term ‘economic double taxation’ sometimes is also used to describe the taxation of a corporation's income which is taxed initially at the corporate level and subsequently at the shareholder level.

Significance of the distinction between the two

In case of juridical double taxation it is an individual whose capital situated and transactions carried out in another country are subjected to the tax. Whereas in case of economic double taxation, the items of income or capital are taxed. The distinction provides assistance to draft rules for avoidance of double taxation and the distinction makes it easy for the development of rules and procedure for avoidance of double taxation for the framers of domestic law.

In the juridical double taxation individuals matter whereas in the economic double taxation it is the company or corporation which is attracted. The distinction makes it easy for the tax policy framers to draft the law providing benefits and attractions to individual or corporations. This distinction avoids a system of loopholes and can decrease the incidence of double taxation. It also limits the extention of sovereign’s command over a foreign territory by limiting the liabilities.

Typical Relief Provided by Tax Treaties

Tax treaties provides relief in many forms like deductions, exemptions, credits, allocation of expenses, and tax sparing. Each of these forms of relief is discussed below:

(a) Deductions

The country of resident allows its taxpayer to ask for deduction of taxes, which have been paid to a foreign government in respect of foreign source income.

(b) Exemptions

Usually country of residence taxes its residents on their domestic-source income and provides an exemption to them from domestic taxes on their foreign-source income. Jurisdiction to tax rests exclusively with the country of source.

Hong Kong is a prominent example which has adopted tax exemption method with respect to all foreign source income earned by their residents. Such countries tax only income form domestic sources. They tax on a territorial basis rather than on worldwide basis. The exemption of foreign source income granted is limited to certain types of income, say like business income and dividends of foreign affiliates.

(c) Credits

Generally reduced domestic taxes are payable by the amount of the foreign tax as a credit of tax already paid and the same is allowed. For example, if A pays a foreign tax of 10 per cent on some foreign source income which suffers a domestic tax of 40 per cent on that income, the foreign tax credit reduces liability of tax from 40 to 30. This method eliminates international double taxation of the residence-source type.

Such countries invariably do not allow tax refunds when their taxpayers pays a foreign income tax at a rate that is higher than the domestic tax rate.3 They also do not allow the excess paid foreign tax to offset imposed taxes on domestic income. The credit for foreign taxes paid is usually limited to the amount of the domestic tax payable on the foreign-source income. There are limitations too, (sometimes quite complex in application) and these limitations are used to prevent inappropriate uses of foreign tax credits. Foreign income is typically taxed at the foreign effective tax rate wherever their rates are higher than the domestic rates. In this system, foreign-source income earned by a resident is generally taxed at a higher rate than the domestic and foreign tax rates.

(d) Allocation of Expenses

Whether a country uses an exemption method or a credit method for providing relief from international double taxation, it allows expenses incurred by its taxpayers between their foreign-source gross income and their domestic-source gross income. Most countries recognize the need for such rules when they are taxing non-residents on their domestic-source income. They routinely deny non-residents a deduction for expenses unless those expenses are properly related to the earning of the domestic income subject to tax. Few countries seem to be as aware of the comparable need to apportion properly the expenses of their domestic
_ _ _ _ _ ____________________________
3. Article 23B of the OECD Model Treaty.

taxpayers between domestic-source and foreign-source income.

(e) Tax Sparing

Tax treaties, provide for “tax sparing,” typically through a tax sparing credit. It is a credit granted by the residence country, to foreign taxes which for some reason were not actually paid to the source country but were payable under the country’s normal tax rules. Non payment of tax or a tax holiday occurs due to tax incentive provided by the source country to foreign investors to encourage to investment and business in the country. In the absence of tax sparing, the actual beneficiary of a tax incentive provided by a source country to attract foreign investment may be the residence country. This happens when the residence country’s (source-country) tax is replaced by an increase in residence-country tax.

Methods Used to Relieve International Double Taxation

Following are the methods used to relieve the burden of double taxation:
· Deduction method. The residence country permits its taxpayer to ask for a deduction of taxes, including income taxes, which have been paid to a foreign government in respect of foreign-source income.
· Exemption method. The residence country allows the taxpayers with an exemption in respect of foreign-source income.
· Credit method. The residence country permits its taxpayers credit against taxes payable for income taxes to a foreign country. In certain cases, the credit is extended to income tax paid to a foreign sub-national government.4
_ _ _ _ _ _________________________
4. Only the exemption method and credit method are accepted norms by OECD Model Treaty and UN Model Treaty.
(a) Deduction Method

For example, consider a 100 deduction for cost of goods sold, which is what was originally paid for the goods. First, we must match this deduction to the income it produces, which is the income from the sales of the goods. The second step is apportionment, where we must identify the percentage of the income that originated from the sale of the goods. Let us suppose that these particular goods are all sold outside the United States, so then the deduction must be apportioned to foreign-source income. However, if 50 percent of the goods were sold in foreign markets and 50 percent in the United States, the deduction is apportioned the same way: 50 percent to the United States and 50 percent overseas. That is apparently a sensible system and is relatively flexible.

As a consequence of deduction method, resident’s earning foreign-source income and payment of income taxes on that income are taxable at a higher combined tax rate compared to the rate applied to domestic-source income. Reluctantly, this method creates a bias in favor of domestic investment compared to foreign investment in the circumstances when the foreign investment is going to attract a foreign income tax.5 And in this way domestic investment is encouraged, and the residents with equal net worldwide income are treated equally as they pay the same domestic tax. From the perspective of the total income (combined domestic and foreign), it is a tax burden on a taxpayer's worldwide income, since the deduction method does not achieve equal treatment of residents. Although residents with equal net worldwide income may pay the same domestic tax, as they pay widely differing amounts of foreign tax. The deduction method is not neutral in terms of the allocation of resources between countries.
_ _ _ _ _ _________________________
5. National self-interest may justify this treatment.
Debit method usually attracts lower rate of tax, in case of income from royalty interest, dividend, personal services, etc. and also in case of no permanent establishment. Business profit having permanent establishment are required to pay tax in other country and no deductions is made at the source.

(b) Credit Method

Income of foreign branch is to be inducted into total income of resident person, and tax is to be worked out at the rate applicable in the country of residence, and tax paid by branch to the other country is to be given credit, and balance if any is payable as part of tax deposited in the other country, and the exceeding tax is payable in the country of person residence and no refund is allowable. Its working is illustration in the following example:

Illustration: US$
A’s income in its country 500
Branch income in another country 500
Total 1000
Tax applicable @ 20% 200
Tax deposited by branch 150
Payable 50

If
A’s income in its country 500
Branch income in another country 500

Total 1000
Tax applicable @ 20% 200
Tax deposited by branch 150
Payable NIL No refund
(c) Exemption Method

Overall effect of the exemption method is that such countries tax only income from domestic sources. Accordingly, tax is levied on territorial basis rather than worldwide basis. Exemption is limited to certain type of income such as business income and dividends from foreign affiliates. It may also be restricted to a minimum rate of tax by foreign country. It is a simple method for administering the tax and eliminates international double taxation. Its working is explained through the following illustration:

Under this method foreign source income is exempted. Jurisdiction to tax rests exclusively with the country of source. This method completely eliminates residence – source international double taxation because of one jurisdiction, the source country imposing tax. The level of foreign tax in the foreign country is not relevant.

Resident person shall be taxed in his country maximum at the rate applicable as per agreement for avoidance of double taxation.

Illustration: US$
A’s income in its country 100
Income tax rate as per resident
Country @ 30% 30
Treaty @ 20% 20
Maximum payment 20

This is how the mechanism of double tax treaties provide relief to tax payers from harmful effects of double taxation.

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ABOUT THE AUTHOR: Zafar Iqbal

Money laundering: Vulnerabilities of insurance sector

The willingness to spend money to hide the origin of the funds attracts the assistance of professional intermediaries, most commonly lawyers, accountants and bankers (every profession has its ethically challenged members), who have appeared in significant numbers to provide their services. Experts who have the ability to cover up the source of funds maintain public offices, and often times high-profile positions, creating and supporting the purported legitimacy of their methods. This comfortable existence, and the profits generated by these activities, has enabled illicit funds to gradually infiltrate the legitimate financial and economic markets.

Over time, this service industry has grown and matured, with the involved professionals assisting in the maintenance of individual criminals and expansion of corruption through their activities. Co-ordination of money movements with legitimate proceeds, in particular, is organized by these service providers to further limit the likelihood of discovery and recovery. These service providers use careful management of the financial balances and the changing jurisdictional rules to prevent or avoid the attention of the regulatory system - sometimes using multiple round trip financial transactions to reduce the possibility of detection.

As facilitators of money laundering, service providers in concert with criminals, seek countries that demonstrate less respect for the global AMI legislation. They use or create shelters, which are often in offshore banking centers that provide both banking services and commercial secrecy. They also supply the human face of trust, which is used to cover large-scale co-ordination of assets controlled by and for the benefit of the criminal money launderer. In this background, this paper seeks to study how money is laundered through insurance policies.

INSURANCE SECTOR Life insurance policies having a cash surrender value are of particular interest to money launders as they provide attractive a money laundering vehicles. The cash value of policies can be redeemed by a money launderer or may be used as a source of further investment of tainted funds, for example, by taking out loans against such cash value of the policy. These policies operate in the same manner as unit trusts or mutual funds ie, a launderer can over-fund the policy and move funds into and out of the policy for the cost of early withdrawal. Annuity contracts pose a significant money laundering risk because they allow a money launderer to exchange his illicit funds for an immediate or deferred income stream. With-profits insurance bonds invested in a mix of shares, fixed-interest securities and property; they become one of the most popular types of lump-sum investment. They are generally promoted as low-risk investments because returns are passed on to policyholders through bonuses and this aspect is very appealing even for those who intend to invest through.1

Payments originating from insurance companies are considered as commonplace by the financial institutions. The money is assumed to be clean and the payments do not attract attention. By placing funds into an insurance policy, money launder makes a significant step in layering and integrating the funds into the financial system. This happens because the beneficiary of an insurance product is often different from the policyholder, hence it is difficult to determine when and for whom to perform customer due diligence?

In cases where an outright purchase of insurance products with criminal cash proceeds has been made, money launderers exploit the fact that insurance products are often sold by brokers and these agents are not acting directly or under the control or supervision of the company that issues the product. The launderer thus seek an insurance broker who is not aware of or does not conform to required procedures, or those who simply fail to recognise or report wanting information in respect of possible money laundering..

For example, a money launderer may purchase marine property and casualty insurance for a phantom ocean-going vessel. He may pay a large premium on the policy so that regular claims are made and payment received. However, such players are careful to ensure that these claims are less than the premium payments, and in this way the insurer enjoys a reasonable profit on the policy;2 and the money launderer are able to receive claim checks which can be used to launder funds. Such funds come from a reputable insurance company, and few question the source of the funds having seen the name of the company on the checks or wire transfer.

There is an inherent risk both in dealing with and in receiving payments from unregulated intermediaries, as they often fail to ensure that thorough due diligence has been conducted on the funds being placed into its policies. It has been noted by a number of experts that insurance firms in many jurisdictions often conduct additional due diligence procedures to manage this particular risk.

Another method used for laundering through insurance policies - specifically used as investment vehicles - is through over payments of the policy premiums and then making request for its reimbursement to a third party. The launderer thus continues to retain the policy as an investment product, while laundering funds are laundered through the additional policy contribution/redemption.

Clients in several countries use the services of an intermediary to purchase insurance policies. Identification is usually taken from the client by way of an ID card, but the details are missing in the documents provided to the local by institution. Such institutions only rely on the intermediary doing due diligence checks.

Another way is that the policy is put in place and the relevant payments are made by the intermediary to the local institution. Then, after a couple of months, the institution receives notification from the client stating that there is now a change in circumstances, and they would like to close the policy due to losses and as a result they come out with a clean checks from the local institution. On some other occasions, the policy would be left to run for a couple of years before being closed with the request that the payment be made to a third party done by.

For example, in a case customs officials in Country X initiated an investigation which identified a narcotics trafficking organisation who utilized the insurance sector to launder proceeds. Investigative efforts by law enforcement agencies in several different countries identified narcotic traffickers were laundering funds through Insurance firm Z located in an off-shore jurisdiction.

Insurance firm Z offers investment products similar to mutual funds. The rate of return is tied to the major world stock market indices so the insurance policies were able to perform as investments. The account holders would over-fund the policy, moving monies into and out of the fund for the cost of the penalty for early withdrawal. The funds would then emerge as a wire transfer or checks from an insurance company and the funds become apparently clean. It is estimated that over USD 29 million has been laundered through this scheme.

VULNERABILITIES The risk may be even more acute when the relative lack of anti-money laundering requirements or other relevant regulations for this sector come into play. Certain jurisdictions with substantial insurance industries have very low numbers of insurance-related suspicious transaction reports, despite rigorous reporting requirements.

Cases involving insurance-related money laundering show that the insurance sector has been significantly used by money launderers, however, due to lack of expertise cases of money laundering has not been detected by the concerned. Some of the experts are of the view that given the size of the insurance industry, its vulnerabilities are too great for money launderers to ignore.

In order to better understand, how and to what degree the various parts of the insurance sector could be used by money launderers, it is proposed that sharing of information on typologies relevant to the insurance sector, can help (both within the industry and between it), law enforcement and supervisory agencies. For example there is high risk:

---- Where business involves cross-border intermediaries and same being not affiliated with or under the control or supervision of the company.

---- Wherever cash is accepted placement risks also exist and it includes intermediaries who do not follow rules or are untrained.

---- Issues of CDD arise where beneficiary and the policyholder are often different - the issues may relate to policyholder only or also for the beneficiary?

In laundering cycle the point of the integration and layering stages are the indicators which may be less obvious, and a different type or degree of diligence is required to identify money laundering. Basic customer identification procedures may be insufficient without more comprehensive customer due diligence.

(The writer is an advocate and is currently working  with Azimuddin Law Associates)

1. Rohan Bedi, Are Insurers Considering Money Laundering Risks?, Insurance Asia, April/May/2005.

2. FATF, Report on Money Laundering Typologies, 2003-2004.