Unfinished Draft – 31/8/07
EU-Israel Trade in the Automobile Sector: Is Israel's High Taxation of Cars Legal under the Association Agreement?
Arie Reich[*]
I.Introduction
In all my courses on International Trade Law or on EU-Israel relationsthat I have taught over the last sixteen years or so, whenever I reach the subject of the free trade area between Israel and the EC and the guarantee of duty-free treatment of goods, I always have the same experience.When told that all manufactured goods made in the ECand imported into Israelare exempt from custom duties under the Association Agreement, my students will always ask me: "How can you say that? Surely you must know that there is a very high duty of over 100% on all imported cars, including those from the EC!" In view of the importance of cars and the considerable financial burden that their high prices put on practically every Israeli, by posing this question my students are not only asking for information on some of the finer details of the Association Agreement, but are in effect expressing their mistrust inthe very essence of myclaimabout free trade between Israel and the EC (or with any of Israel's other free trade partners). My attempts to explain that cars from the EC are really exempt from custom duties, and are only subject to Purchase Tax and Value Added Tax (VAT) and that the latter do not amount to "charges having equivalent effect" to custom duties since they are imposed on locally-made and imported cares alike, are usually met with laughter. The reason is simple: everybody knows that there is virtually no car manufacturing in Israel, and thus the only ones who pay the high purchase tax are the importers. I usually persist with my thesis claiming that since there is no discrimination involved, and since the purchase tax cannot be claimed to protect the domestic industry, one must conclude that the high purchase tax on cars is perfectly legal under the Association Agreement.
Now, however, I would like to question this proposition. I would like to suggest that perhaps my students' intuitive reaction is the more correct one. Indeed, how can a tax that in practice is imposed only on imports and which by virtue of its extremely high levels clearly has a significant impact on trade volumes, be said to be compatible with free trade? Isn't it an obstacle to the free movement of goods that should have been removed by over thirty years of economic integration between Israel and the EU? In this paper I would like to examine this question both from a legal point of view,mainly in light of case law of the European Court of Justice (the ECJ) and possible interpretations of the existing Association Agreement, as well as from an efficiency perspective. Within the latter perspective we will ask ourselves what the costs and benefits of the current policy are, and whether it is justified from a normative standpoint.
II.Background: Israel's Purchase Tax on Automobiles
Cars that are commercially imported into Israel are subject to several taxes. Cars originating from countries with which Israel has no free trade agreement are subject to a customs duty at the rate of 7% ad valorem. Cars made in and imported from countries which have concluded free trade agreements with Israel (such as the EC, EFTA, USA, Canada, Turkey and Mexico) are not subject to any customs duty. However, they, and all other imported cars, are subject to a purchase tax which until 2005 amounted to 95% on private vehicles and 75% on commercial vehicles. In addition they are subject to VAT, which currently stands at 15.5% (and formerly was as high as 18%), and a port fee of 1.02%. In 2005, the Israeli Government initiated a reform program aimed at reducing the purchase tax on cars and equalizing the rates that apply to private and commercial vehicles. Accordingly, at present (2007) the rate of purchase tax for private vehicles is 84% and for commercial vehicles it is 72%. In 2010, the target date of the reform, the rates for all types of cars are planned to converge at 72%.[1]
The purchase tax is imposed by the Minister of Finance pursuant to the Purchase Tax Law (Goods and Services), 1952.[2]The types of products that are subject to the tax and its rates are determined by decrees issued by the Minister, usually on an annual basis, based on the authorization found in Article 3 of this law.The purchase tax is imposed on the so-called "normal value" of the car, determined according to the provisions of the Customs Ordinance, which is made up of the ex-factory price of the car, plus freight and insurance costs until the Israeli port (know as CIF price), plus the port fee (1.02%) and other port expenses, and plus the customs duty (7%) if it applies. Some credits are then allowed if the car has certain safety components, such as airbags.In addition to the purchase tax, the importer must also pay the VAT (15.5%) which is assessed on the normal value, plus the customs duty (if applicable) and plus the purchase tax. Thus, in effect, the total tax burden for private cars from the EU at importation is close to 140% on the ex-factory price of the car.[3]There are also significant rates of purchase tax on spare parts and accessories for cars.
Purchase tax is imposed on goods imported into Israel by virtue of their import, and on goods produced locally by virtue of their first sale. The tax is collected by the Israel customs authorities, which are in charge of the collection of all other import taxes, such as customs duties, anti-dumping duties, countervailing duties, and safeguard charges.The liability and rates of the purchase tax is imposed by the same legislative means as custom duties, namely the "Decree on Customs Duties, Exemptions and Purchase Tax on Goods" (צו תעריף המכס והפטורים ומס קניה על טובין), the law provides that the Customs Duties and Excise Law, 1949 will apply to decrees pursuant to the Purchase Tax Law,[4] and the value of the goods for the purpose of determining the amount of liability is also to beassessed as it is for customs duties purposes.[5] Thus, for all intents and purposes it is treated just like a customs duty and goods cannot be brought into free circulation in Israel until the purchase tax and all other import taxes have been paid or guaranteed. While purchase tax on local production is only due at the time of sale by the producer to the first buyer, importers are required to pay the taxbefore the goods are released from the custody of the custom authorities (Art. 5).
The cumulative effect of all these taxes is that the effective tax burden imposed on cars in Israel is one the highest in the world (Israel Tax Authority, 2005). It can amount to over 140%of the car's net price,[6] compared to up to 40% in Europe.[7]This heavy burden has significant economic, social and environmental implications: (1) The purchase of a new car becomes a major expense and outside the reach ofa large part of the population. Figure I below shows that the number of cars in Israel per inhabitant is significantly lower than in other countries with similar GDP;
(2) It hampers the ability of a car owner to change his car to a newer and safer model. Cars in Israel are kept and driven for a longer time than in other developed countries,[8] and the older car fleet on Israeli roads means less car safety and more air-pollution. A public commission on road safety in Israel, appointed by the Minister of Transportation and headed by the distinguished economist Dr. Jacob Sheinin, found in 2005 that the relatively high age of cars in Israel is one of the reasons for the high accident rate (Sheinin, 2005).[9] The commission therefore recommended changes in the purchase tax system in order to bring down the average age of cars in Israel and increase their safety.As for air-pollution, according to figures of Israel's Ministry of Environmental Protection, old cars are today the main source of this pollution, much more than their relative portion in the car fleet. This stems from the fact that they were built according to old technologies and as they grow older they pollute even more. For instance, the emission of nitrogen oxides of cars manufactured before 1992 are about seven times higher than cars manufactured after 1992, and the emission of carbon monoxide about five times higher (Ministry of Environmental Protection, 2007).
(3) Finally, the high prices of cars also create strong incentives for car thefts. Such thefts are proportionally more common in Israel than in any other Western country, reaching about 33,000 thefts annually, with about 15,000 taken apart for spare parts.[10]The annual loss to the economy is estimated at over $200million. As a result of this and the high car prices, insurance rates have also skyrocketed, falling outside the reach of many families.
Figure 1
GDP* for a person, in PPP**
*Gross Domestic Product
**Purchasing Power Parities
III.The Israel-EC Association Agreement: The Relevant Provisions
The Israel-EC Association Agreement was signed in 1995 and came into full force after ratification in all Member States in 2000.[11]It replaced a prior free trade agreement signed in 1975. Its stated aim is to further integrate Israel's economy into the European economy, and "to promote the harmonious development of economic relations between the Community and Israel and thus to foster in the Community and in Israel the advance of economic activity, the improvement of living and employment conditions, and increased productivity and financial stability" (Article 1.2). It reinforces the free trade area in goods that was already in place between the two countries and expands and strengthens it in various aspects. It also establishes a binding dispute resolution mechanism, which did not exist in the previous agreement. This mechanism enables a party to the Agreement (i.e., either Israel or the EC) to bring a dispute relating to the interpretation or application of the agreement before a panel of arbitrators, which may render a binding decision (Article 75).
The provisions that are relevant to our discussion of the taxation of car imports from the EU are mainly Articles 8, 16 and 18. Article 8 of the Agreement provides:
Customs duties on imports and exports, and any charges having equivalent effect, shall be prohibited between the Community and Israel. This shall also apply to customs duties of a fiscal nature.
This provision is almost identical word for word to EC Treaty Article 25, which applies to the free movement of goods between EC Member States.It prohibits not only the application of any custom duties on imports or on exports, but also any "charges having equivalent effect", i.e., equivalent effect to the effect of a custom duty. Thus, in order to determine whether a certain charge falls within this prohibition, one must determine what the effect of a custom duty is and whether the effect of the charge in question is somehow equivalent to this.
The next relevant provision is Article 16 of the Association Agreement which provides:
Quantitative restrictions on imports and all measures having equivalent effect shall be prohibited between the Community and Israel.
This provision is identical to EC Treaty Article 28, which imposes the same prohibition as between EC Member States. It applies to quantitative restrictions, such as quotas, as well as all measures having equivalent effect to that of a quantitative restriction.
Finally, a provision which may be of relevance is Article 19 of the Association Agreement, which provides:
“The Parties shall refrain from any measure or practice of an internal fiscal nature establishing, whether directly or indirectly, discrimination between the products of one Party and like products originating in the territory of the other Party.”
This provision is somewhat similar to EC Treaty Article 90, which prohibits anyMemberState from imposing on products of other MemberStates any internal taxation in excess of that imposed directly or indirectly on similar products, or any internal taxation which affords indirect protection to other products. While the wording of the two provisions is different ("taxation" versus "fiscal measure or practice"; and "discrimination" versus "in excess of" and "indirect protection"), the essence of the two provisions is quite the same: to prohibit internal tax measures which do not amount to "measures of equivalent effect" but which nevertheless result in discrimination of imported products and thereby protection of the domestic industry.
- Is Israel's Purchase Tax on Automobiles Legal Under the Association Agreement?
1.The Objective of the Association Agreement: Free Movement of Goods
As we have seen, the EU-Israel Association Agreement aims to reinforce the free trade area between the parties, to expand trade in goods and services and to further integrate Israel's economy into the European economy (Preamble and Article 1 of the Agreement). It aims to achieve free movement of goods between the parties, as is evidenced from the heading of Title II ("Free Movement of Goods"), under which all of the provisions cited above are found. For that purpose, the Agreement requires the elimination of all custom duties and quantitative restrictions on trade between the parties, so that there will be no obstacles to the free flow of industrial goods between Israel and the EC.
However, it is a well known fact in international trade that movement of goods can be obstructed not just by custom duties and quotas, but also by less explicit and more indirect types of trade barriers.While the name of the measures may differ, and sometimes also the manner in which they are imposed and function, their trade distorting effect is often equivalent to that of traditional trade barriers. If such measures were to be allowed, it would be easy to circumvent the agreements and to block imports by all kind of measures with different names. In order to prevent this, international trade agreements therefore often prohibit also all other types of measures if theireffect is equivalent to that of custom duties or quotas. That is indeed what the EU-Israel Association Agreement has done in Article 8 and 16.
2.How to Interpret "Charges of Equivalent Effect"?
What exactly is the meaning of "charges having equivalent effect" as referred to in Article 8? Since this term is found also in the EC Treaty (Article 25) and has been subject to many judgments of the European Court of Justice (the "Court"), we can find guidance in these decisions. Of course, the Court does not bind Israel in its decisions, and the judgments in questions were given in relation to the EC Treaty and not the Association Agreement. It is also true, that generally the aim of the EC Treaty - namely, full economic integration between the Member States of the EU into one single common market - is much more ambitious than that of the Association Agreement between Israel and the EU. Considering that according to the Vienna Convention on the Law of Treaties, a treaty "shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose" (Article 31(1)), the somewhat different objects and purposes of the two agreements may therefore sometimes lead to different interpretations of the same terms as they appear in the two treaties. However, in relation to the correct interpretation of the term "charge of equivalent effect" the respective objects and purposes of the treaties are not so much different: both treaties aim to establish a free trade area between their respective parties (it should be noted that such an area is one of the components of the common market established in the EU) and to achieve free movement of goods (as evident from the identical headings in both treaties[12]).Moreover, when the Association Agreement was concluded in 1995 between Israel and the EU, there was already a well-established jurisprudence on the exact meaning and scope of the term "charges of equivalent effect", both by the Court and by other judicial bodies and one can safely assume that both parties were aware of this jurisprudence. Thus, in the absence of any reservation by any of the parties to the contrary, it is reasonable to conclude that when using this term in their agreement the parties intended to adopt it in accordance with its ordinary and well-established meaning.
3.The Case Law of the European Court of Justice
In Case 77/72Capolongo v. Maya[13]the Court held that a "charge having an equivalent effect" includes any tax demanded at the time of, or by reason of, importation and which results in the same restrictive consequences on the free movement of goods as a customs duty by altering the cost price of that product. When such a tax, even if not at a significant rate, is imposed specifically on an imported product, to the exclusion of the similar domestic product, it alters the competitive conditions between these two competing products to the benefit of the domestic product, and it can easily be understood why the Court saw such a tax as having equivalent effect to a customs duty. But when no similar domestic product exists, and the tax cannot be seen as protecting or benefiting the domestic production of such a similar product, can one still consider a tax as having equivalent effect to a customs duty on the mere account of its obstructing the free movement of goods?