Interaction of Tax Incentives and Performance Requirements in Bilateral Investment Treaties: Its Role in Implementing Right Institutions in Developing Countries
FORDHAM INTERNATIONAL LAW JOURNAL [Vol.
Fordham International Law Journal
Tae Jung Parky
TAE JUNG PARK**
After a failure of the Washington Consensus, many recommend
that developing countries implement right institutions (i.e. institutions
that are tailored to local environments and socio and political cultures)
for further development. Bilateral Investment Treaties (hereinafter
“BITs”) could be a good alternative instrument to establish the right
institutions since the treaties significantly impact the institutions of
one’s nation. The essay introduces ways to carve out a lawful
combination of tax incentives and performance requirements in BITs,
which could may foster right institutions in developing countries. This
essay contributes to the literature by 1) reconciling the concept of right
institutions in law and development with the BIT literature and 2)
examining the methods to identify certain types of tax incentives and
* Professor of International Economic Law, City, University of London
** A Legal Advisor in the International Legal Affairs Division, Ministry of Justice, South
Korea. A formal investment treaty negotiator in the Ministry of Trade, Industry and Energy,
South Korea. SJD candidate (UVA School of Law), JD (Case Western Reserve Law), LLM
(Northwestern University School of Law), MA (Yale University) BA (Cornell University). The
views or opinions expressed herein are the author’s alone and do not reflect the views or opinions
of the Ministry of Justice or the Ministry of Trade, Industry and Energy in South Korea.
<>. All remaining errors and misconceptions are entirely my responsibility.
Both authors equally contributed to the work.
performance requirements lawfully and their implications on right
institutions in developing and emerging nations.
II. TAX INCENTIVES AND PERFORMANCE
REQUIREMENTS IN BILATERAL INVESTMENT
A. TAX INCENTIVES .........................................................213
B. PERFORMANCE REQUIREMENTS ..................................214
C. MODEL BILATERAL INVESTMENT TREATY 2012..........216 III. CONCLUSION .................................................................225
The Washington Consensus1 (i.e. heavily standardized policies
that focus primarily on market liberalization and privatization
employed throughout the late 20th and early 21st centuries), while
arguably effective in the developed world, has failed to provide the
strategies needed for further economic growth in developing countries2,
even though each of its policies made sense for a particular country at
a particular time.3
1. Washington Consensus is a shared set of opinions on “effective development strategies
that have come to be associated with Washington-based institutions: the [International Monetary
Fund (“IMF”)], the World Bank, and the US Treasury.” The Washington Consensus is based on
three underlying principles: market economy, openness to the world market, and
macroeconomic discipline. Generally, the Washington Consensus is “market fundamentalism,”
the notion that the free market is the solution to most economic problems. See NARCIS SERRA
ET AL., THE WASHINGTON CONSENSUS RECONSIDERED 3 (Narcis Serra & Joseph E. Stiglitz,
2. J.E. STIGLITZ, The Post Washington Consensus, THE INITIATIVE FOR POLICY
http://intldept.uoregon.edu/wp-content/uploads/2015/03/Yarris-Joya-5.1.15Brown-Bag-Article.pdf [https://perma.cc/G2TV-RYL3] (last visited Oct. 24, 2017).
3. See JOSEPH E. STIGLITZ, GLOBALIZATION AND ITS DISCONTENTS 52 (2002).
The progressive removal of trade barriers through the General
Agreement on Tariffs and Trade (“GATT”) and the World Trade
Organization (“WTO”), have contributed to the raising of living
standards throughout many parts of the world while exacerbating
inequalities in industrialized nations.4 Many scholars agree that this is
because developing countries failed to establish “right institutions”5
(i.e., a series of regulatory measures that that reflect the local market
conditions and culture) that are critical for the Washington Consensus
policies to perform well.6
The three major international organizations associated with the
Washington Consensus – namely the Bretton Woods triumvirate of the
WTO, the International Monetary Fund (“IMF”), and the World Bank,
have recognized the problem of underdevelopment throughout the
world but have been unsuccessful in establishing right institutions in
developing countries. The IMF and the World Bank started “ownership
programs” in order to allow developing countries to draft their policy
conditionality 7 by themselves, because those countries presumably
know best their local market conditions or culture in order to establish
4. See JACKSON ET AL, LEGAL PROBLEMS OF INTERNATIONAL ECONOMIC RELATIONS,
CASES MATERIALS, AND TEXT 21 (5th ed. 2008).
5. The term “right institutions” refers to institutions that are tailored to the local
environment or culture of a state. Because developing nations are different from developed
nations in that they face many different constraints and challenges, so institutions that tend to
perform well in developed nations may not work well in developing nations. Developing nations
do not require an extensive set of institutional reforms. Rather, they need to diagnose their own
problems and find an “appropriate” arrangements to further their growth. By doing so, the
developing nations can find their own country-specific development paths based on their
institutional capacity. In other words, developing countries should adopt experimental attitudes
for policy formulation and selection because the economy of each developing state is at a
different stage and each state has a different institutional capacity. See generally DANI RODRIK,
ONE ECONOMICS MANY RECIPES, GLOBALIZATION, INSTITUTIONS, AND ECONOMIC GROWTH
229 (2008) (arguing that the establishment of “right institution” is a critical element of further
economic growth for developing nations).
6. This essay uses the concept of “institution” in an open-ended manner to include not only
organizations but also regulatory frameworks with economic agendas. See generally JAN
KLABBERS, AN INTRODUCTION TO INSTITUTIONAL LAW 3 (2009) (“there is no firm line dividing
the institutional from the substantive”).
7. Conditionality is the attachment of conditions to the provision of benefits such as a loan,
debt relief, or bilateral aid. These conditions are typically imposed by international financial
institutions or regional organizations and are intended to improve economic conditions within
the loan recipient country. See IMF Conditionality, INTERNATIONAL MONETARY FUND,
[https://perma.cc/H3VA-Y4CE] (last visited Oct. 24, 2017).
their own right institutions.8 The results, however, are unsatisfactory.9
The IMF and the World Bank are criticized about their continuous and
unnecessary interventions into the conditionality drafting process.10
For its part, the WTO recently promulgated the Trade Facilitation
Agreement aimed at removing bureaucratic barriers to the transit of
goods across international frontiers in developing countries, however
whether it will succeed in operation is another question, as many of the
world’s poorest countries lack the infrastructure necessary to achieve
its aims. Similarly, the WTO’s provisions on Special and Differential
Treatment for developing countries have yet to be effectively
implemented by the countries they were designed to help.11
Over the past few decades, Bilateral Investment Treaties (“BIT”s)
aimed at increasing foreign investment flows, have been regarded as an
instrument for Washington Consensus and neo-liberalist ideas.12 The
8 . See Graham Bird, Reforming IMF Conditionality: From ‘Streamlining’ to ‘Major
Overhaul’, 10 WORLD ECON. 81, 91 (2009)
(For instance, the IMF approved new conditionality
guidelines in its “streamlining” initiative in 2002 aimed at reducing the number of conditions to
include only structural conditions that were deemed critical to the overall success of the program.
The main purpose of the new guidelines was to encourage stronger ownership by host states of
economic reform to make the IMF program more effective and to ensure that conditionality was
more tailored to recipient countries’ different economics situations and cultures. Consequently,
the IMF has allowed countries receiving loans to be primarily responsible for selecting,
designing, and implementing policies that will make the conditionality program successful.
However, contrary to the IMF’s expectations, the new guidelines on conditionality have failed.
Although recipient countries draft letters of intent, in most cases the IMF determines the
specificity of the conditions while recipient countries lack significant space to negotiate changes
to the conditionality. Certain national authorities continue to complain about IMF inflexibility
and perceive the IMF as an agent for imposing the “Washington-Consensus-like” policies)
also James M. Boughton, Who’s in Charge? Ownership and Conditionality in IMF-Supported
Programs 9 (Int’l Monetary Fund, Working Paper No. WP/03/191, 2003).
9. Bird, supra note 8 at 100.
10. See Structural adjustment, Criticisms, WIKIPEDIA, https://en.wikipedia.org/wiki/
Structural_adjustment [https://perma.cc/4GM8-5FNR] (last visited Nov. 1, 2017).
11. See generally Thomas Fritz, Special and Differential Treatment for Development
Countries, 18 GLOBAL ISSUE PAPERS (2005), https://germanwatch.org/tw/sdt05e.pdf
[https://perma.cc/3MGB-FF5U] (last visited Oct. 24, 2017).
12. See generally M. Sornarajah, Mutations of Neo-Liberalism in International Investment
Law, 3 TRADE L. & DEV. 203, 210-15 (2011) (Neo-liberalism refers to the revival of market
fundamentalism in the post-Cold War period because of the failure of communism in the Soviet
Union. The paper classifies four stages of international investment law and defining the third
stage as an era related to the preference for market-based solution. The ascendancy of
neoliberalism in 1990’s led to the development of secure investment protection norms based on the
notion that investment flows would be promoted through the neo-liberal philosophy that came
do dominate in this period. This is probably rooted in the dissolution of the Soviet Union, which
signaled the end of communism and left democracy and market fundamentalism as the
prevailing philosophy at the end of the Cold War).
assumption behind this was that foreign investment was so crucial to
economic development that its flow should be facilitated through
strong protection for investors. The protections are in the form of
guarantees against expropriation without compensation and vague
concepts like Fair and Equitable Treatment, even where this posed a
risk that host states would face liability in investment tribunals for
monetary compensation of multinationals. 13 The wisdom of this
proposition is currently undergoing major criticism because many
developing states that adopted Washington Consensus and neo-liberal
policies through investment treaties experienced low economic
development, which has resulted in an overall decline in economic
growth. 14 Others, have witnessed widening gaps between the rich and
the poor.15 Signed BITs ultimately caused governments in developing
countries to lose their economic sovereignty, which in turn,
substantially reduced their policy space for implementing the right
institutions geared to their economic and social needs.
Based upon this, this essay views international investment law, as
captured by the regime of global BITs and variously interpreted and
applied by investment tribunals, as a better instrument to implement the
right institutions because of its capacity for flexibility and case-by-case
customization. International investment law is depicted as a suitable
alternative to the stifling conditional programs imposed by the IMF and
the World Bank, and the largely ineffectual trade norms of the WTO as
encompassed by the Washington Consensus packaged “solution.” The
BITs, of which there are now more than 3,000, with many signed by
developing nations—could instead help these countries in establishing
their own “right” or “appropriate” institutions. This is because BITs,
while framed as a series of international legal obligations that are
themselves largely standardized, reveal the capacity for the creation of
13. Kenneth J. Vandevelde, BILATERAL INVESTMENT TREATIES, HISTORY, POLICY, AND
14. Sornarajah, supra note 12, at 203 (explaining how signing the investment treaties
resulted a economic failure. Argentina, for instance, signed several investment treaties, including
one with United States. The neo-liberal policies led to an economic crisis that resulted in a
devaluation of the state’s currency by the government used, which adversely affected foreign
investors. This measure resulted in forty-six claims for investment treaty violations, which
incurred billions of dollars in adverse arbitral awards against Argentina).
15. See Vandevelde, supra note 13, at 92.
highly individualized domestic
developing host countries.16
Following from the above, this essay will introduce the ways to
carve out certain types of tax incentives contingent on a particular,
often unexplored feature of BITs, namely those which deal with the
control of performance requirements. Generally, BITs do not apply to
tax measures.17 That is, host countries have total discretion to exercise
their tax incentives policies irrespective of signing BITs. However,
many developing nations fail to recognize that prohibition of
performance requirement18 provisions in BITs restrict a certain form of
tax incentives that are contingent on host states imposing performance
requirements on investors as a condition of entry or receipt of favorable
treatment under domestic laws. This becomes a critical problem when
a combination of tax incentives and performance requirement is
actually the right institutions that is needed as a developmental strategy
for a given nation.
The essay illustrates how tax incentives and performance
requirements interact with each other and introduce methods by which
an economic policy environment may be established which is both
legal and, crucially, conducive to development. As such it may be
termed the right institutions, or institutional framework, to contrast to
the ponderous and oppressive prescriptions of the IMF and World
Bank. Academic legal literature has paid limited attention to the
16. JESWALD W. SALACUSE, THE LAW OF INVESTMENT TREATIES 129 (2d ed. 2014)
(explaining that the BIT affects the institutional arrangement of host countries); Joshua Boone,
How Developing Countries Can Adapt Current Bilateral Investment Treaties to Provide Benefits
to Their Domestic Economies, 187 GLOBAL BUS. L. REV. 187, 196-97 (2011) (This article
claims that performance requirements are likely the most powerful regulatory methods for
developing countries. A developing nation should require technology transfers or limitations on
technology licensing fees. This helps establish new markets and increase efficiency and
production within the new domestic market of a developing state because it would allow the
country to use, acquire, produce, and adapt foreign technology).
17. Maira De Melo Vieira, The Regulation of Tax Matter in Bilateral Investment Treaties:
A Dispute Resolution Perspective, DISP. RESOL. INT’L 63, 67 (2014).
18. DAVID COLLINS, PERFORMANCE REQUIREMENTS AND INVESTMENT INCENTIVES
UNDER INTERNATIONAL ECONOMIC LAW 9-10 (2015) (explains that there is no universally
adopted definition of performance requirements. Some describe them as all “host state country
operational measures.” In general, the term “performance requirements” refers to a variety of
regulatory measures imposed by host state governments on the activities of foreign investors.
Performance requirements take the form of various conditions imposed upon foreign investors.
For example, a host country could require a foreign investor to form a joint venture with a local
business or require the foreign investor to possess a certain quantity of foreign capital to fund
performance requirement provisions in BITs and their impact on tax
incentives. In contrast, this essay will demonstrate how performance
requirements interact with tax incentives and the ensuing its
implications as a tool of development. More specifically, this essay will
illustrate how developing states could carve out tax incentives
contingent on performance requirements based on the wording found
in the US Model BIT 2012.
II. TAX INCENTIVES AND PERFORMANCE REQUIREMENTS
IN BILATERAL INVESTMENT TREATIES
This section will first briefly introduce the concepts of tax
incentives and performance requirements and then explain how they
are dealt with under international law.
A. TAX INCENTIVES
Investment incentives can be defined as any measurable
advantages accorded to specific firms by a host government to
encourage them to engage in operations of a certain variety; typically,
this means foreign direct investment (“FDI”) in a certain sector.19
Investment incentives are akin to subsidies in that they grant
advantages to certain firms which allow these firms to operate in a
favorable position in their respective markets. Unlike performance
requirements, incentives are not generally controlled by international
law. The only international legal instrument which affects the use of
incentives is in the context of trade law where subsidies assisting goods
aimed at export markets are prohibited.20 Some investment treaties also
have a minor limiting impact on the use of investment incentives. For
example, North American Free Trade Agreement (“NAFTA”) denies
parties the ability to attract foreign investors by lowering regulatory
standards of certain areas, notably the environment.21
Simply put, a tax incentive is an aspect of a country’s tax code
designed to incentivize, or encourage a particular economic activity.
They are special exclusions, exemptions, or deductions that provide
19. See id. at 2.
20 . See generally WORLD TRADE ORGANIZATION, AGREEMENT ON SUBSIDIES AND
COUNTERVAILING MEASURES (1995) [hereinafter ACSM].
21. North American Free Trade Agreement, art. 1114(2), Can.-Mex.-U.S., Dec. 17, 1992,
32 I.L.M. 289, 642 (1993) [hereinafter NAFTA].
special credits, preferential tax rates or deferral of tax liability.22 Tax
incentives take a variety of forms such as reduced corporate income tax
rates, tax holidays, investment credits, sales tax or VAT reductions, and
property tax reductions. Incentives are sometimes broadly or narrowly
targeted. Tax incentives could specifically target export-oriented
investment or the research and development sector depending upon
ones’ policy preferences.
Tax incentives have many advantages. 23 First, tax incentives
encourage technology spill overs and hire more local employees, which
increase the level of FDI.24 However, tax incentives may also have a
downside. For instance, it can lead to a market distortion by presenting
an artificial advantage to certain forms of economic activity and not
others, leading to a misallocation of resources in production and
consumption. If tax incentives are successful, they will spur additional
investment in a sector that would not otherwise have occurred. This
investment will reallocate resources, which may result in too much
investment in certain sectors or too little investment in another sector.
Corruption on the part of those who seek tax incentives and the high
cost of enforcement and compliance are other problems associated with
the use of tax incentives. This is one reason why scholars have
identified tax incentives, at least as tools of attracting FDI, as
something of a “winner’s curse”—the country that out-competes all
other countries in offering the most attractive tax incentives may end
up losing out in the long term.25
B. PERFORMANCE REQUIREMENTS
There is no universally adopted definition of “performance
requirements.” Some describe performance requirements as all “host
state control techniques on operational level.” 26 As noted above,
usually performance requirements are described as conditions imposed
on foreign investors that require they achieve certain goals with respect
to their commercial activities in host countries. Performance
requirements are used with other policy tools, such as traditional
investment incentives, to attain certain economic development
objectives. Performance requirements may compel a foreign firm to
adopt a certain structure, such as a joint venture with a local partner, or
possess a certain quantity of foreign capital to fund their operations.
Performance requirements may appear to be the counterpart to
investment incentives in that they impose obligations on investors,
while investment incentives grant them rights.
Performance requirements are prohibited by most BITs and by the
WTO’s Agreement on Trade-Related Investment Measures
(“TRIMs”). This is based on the notion that such requirements control
the behavior of foreign investors in a manner which is distortive of
international markets and, therefore, counterproductive. In the case of
TRIMs, a subset of performance requirements known as “trade-related
investment measures” are prohibited because they compel foreign
firms to use domestic goods, even where these may be more expensive
or of lower quality. 27 This provision of TRIMs reiterates that the
national treatment requirement found in Article 3 of the GATT, which
essentially prohibits discrimination against foreign goods, the
foundation of the WTO’s emphasis on liberalized trade. Developing
countries prefer to utilize TRIMS measure, due to its important nature
in the economic policy of pre-industrialized or newly industrializing
Most of the prohibitions on performance requirements in BITs
consist of a simple restatement of the obligations imposed under
TRIMs, which means TRIM signatory states which are also WTO
Members would already be required to not impose such measures on
foreign firms regardless of the BIT. However, some modern BITs go
beyond this standard provision by specifying a broader range of
performance requirements that are illegal under TRIMs. For example,
in addition to the TRIMs prohibitions, NAFTA also prohibits signatory
states from imposing technology-transfer obligations on foreign
firms.29 The purpose of this prohibition appears to be the recognition
27 . WTO, AGREEMENT ON TRADE-RELATED INVESTMENT MEASURES art. 2 (1994)
28. COLLINS, supra note 18, at 117.
29. NAFTA, supra note 22, art. 1106(1)(f), 32 I.L.M. at 605.
that such a requirement would place an undue burden on a foreign firm,
placing it at a competitive disadvantage in the domestic market
compared to local firms which do not suffer from this obligation.
C. MODEL BILATERAL INVESTMENT TREATY 201230
Having introduced the key concepts of tax incentives and
performance requirements, this section examines how different types
of tax incentives could be carved out through performance requirement
provisions in BITs, using the US Model BIT 2012 as a representative
example of such a treaty. This essay argues that such a carve out would
provide opportunities for developing nations to design and protect their
locally tailored tax incentives. These are the “right institutions”,
meaning packages of regulations aimed at achieving economic
It should be mentioned that studies on reconciling taxes with BITs
are in their early stages.31 Researchers argue BITs should regulate tax
measures since the tax treaty failed to work as promised.32 Others reject
this, arguing that tax measures should be governed only by tax treaties
30. In February 2009, the Obama Administration initiated a review of the US Model BIT
to ensure it was consistent with the public interest and the Administration’s overall economic
agenda. The Administration sought and received extensive input from Congress, companies,
business associations, labor groups, environmental and other non-governmental organizations,
and academics. The US Model BIT 2012 maintains language from the 2004 model BIT, in
particular its carefully calibrated balance between providing strong investor protections and
preserving the ability of the host government to regulate for the public interest. Despite these
similarities, the Administration made several targeted and important changes from the previous
model text to improve protections for American firms, promote transparency, and strengthen the
protection of labor rights and the environment. See US DEP’T OF ST., UNITED STATES
CONCLUDES REVIEW OF MODEL BILATERAL INVESTMENT TREATY, Media Note (Apr. 20,
[https://perma.cc/W3V76PKV] (last visited Oct. 24, 2017).
31. See generally Thomas W. Wälde & Abba Kolo, Coverage of Taxation under Modern
Investment Treaties, in THE OXFORD HANDBOOK OF INTERNATIONAL INVESTMENT LAW (Peter
Muchlinski et al. eds., 2008).
32. Reuven S. Avi-Yonah & Oz Halabi, Double or Nothing: A Tax Treaty for the 21st
Century, 3 (Mich. Law & Econ., Working Paper No. 66, 2012), http://repository.law.umich.
[https://perma.cc/H327ARK7] (last visited Oct. 24, 2017) (arguing that tax treaties are in fact superfluous for corporate
tax payers and that it would be better to protect them from exorbitant source-country-specific
taxation by including tax provisions in BITs since such BITs have much stronger dispute
resolution mechanisms and have most favored nation (“MFN”) provisions, so they effectively
form a multilateral network).
because BITs and tax treaties have different functions and purposes.33
Recently, scholars have examined how each provision in a BIT is
relevant to the assessment and enforcement of municipal tax
impositions by considering “ways in which common practices can be
perverted to impair investments, rather than to advance the appropriate
revenue goal of the state.”34
The general rule is that tax incentives may be exempt from the
obligations contained in a BIT. Some BITs use a general exception to
carve out all kinds tax measures. For example, Article 16 of the
Canada-Mongolia BIT specifies:
7. Articles 6 (Minimum Standard of Treatment), 7 (Compensation
for Losses), 8 (Senior Management, Boards of Directors and Entry
of Personnel), 9 (Performance Requirements) and 11 (Transfers)
shall not apply to taxation measures. 35
Other BITs contain a separate taxation clause stating the BIT does
not apply to tax measures and that the tax treaty overrides the BIT if
there is any conflict between the two.36
However, the general rule never justifies developing nations
freely exercising their tax incentives in any circumstance, meaning in
a manner that might transgress the prohibition on performance
requirements alluded to above. Many BITs, including the US Model
BIT 2012, have certain restrictions on the allowance of the tax
incentive measures. Unfortunately, many developing nations do not
appreciate the nature of these restrictions and sign the BITs regardless,
restricting their capacity to engage certain policies aimed at enhancing
their development potential. This is probably because of their unequal
bargaining power and lack of negotiation skills.37 It is now well known
that developing countries have limited ability to modify the terms of
the model BITs presented to them by more economically powerful
nations, such as the United States.38 This is why most ratified BITs, at
least those between the United States and foreign investors, are broadly
similar to those between developing nations and foreign investors in
terms of their contents.39
The following is an excerpt from the US Model BIT 2012 that
many developing nations have accepted as the baseline for their BITs
with the United States. The essay will now examine how the US Model
BIT 2012 restricts certain forms of tax incentives measures:
Article 21: Taxation
1. Except as provided in this Article, nothing in Section A shall
impose obligations with respect to taxation measures . . .
3. Subject to paragraph 4, Article 8 [Performance Requirements]
(2) through (4) shall apply to all taxation measures.
4. Nothing in this Treaty shall affect the rights and obligations of either Party under any tax convention. In the event of any
inconsistency between this Treaty and any such convention, that
convention shall prevail to the extent of the inconsistency. In the
case of a tax convention between the Parties, the competent
authorities under that convention shall have sole responsibility for
determining whether any inconsistency exists between this Treaty
and that convention.40
The first paragraph of Article 21 carves out tax measures from the
main text of the agreement. In other words, the Model BIT 2012
generally does not apply to tax measures. The second paragraph lists
exceptions to the first paragraph, stating that some of the performance
requirements listed in Article 8 apply to all tax measures. The following
is Article 8 in the US Model BIT 2012. Its language is inspired by that
of TRIM, discussed in Part II.B above:
Article 8. Performance Requirement
1. Neither Party may, in connection with the establishment,
acquisition, expansion, management, conduct, operation, or sale or
other disposition of an investment of an investor of a Party or of a
non-Party in its territory, impose or enforce any requirement or
enforce any commitment or undertaking:
(a) to export a given level or percentage of goods or services;
(b) to achieve a given level or percentage of domestic content;
(c) to purchase, use, or accord a preference to goods produced in
its territory, or to purchase goods from persons in its territory;
(d) to relate in any way the volume or value of imports to the
volume or value of exports or to the amount of foreign exchange
inflows associated with such investment;
(e) to restrict sales of goods or services in its territory that such
investment produces or supplies by relating such sales in any way
to the volume or value of its exports or foreign exchange earnings;
(f) to transfer a particular technology, a production process, or
other proprietary knowledge to a person in its territory;
(g) to supply exclusively from the territory of the Party the goods
that such investment produces or the services that it supplies to a
specific regional market or to the world market; or
40. 2012 US Model BIT, art. 21(1), (3), & (4), https://ustr.gov/sites/default/files/BIT
%20text%20for%20ACIEP%20Meeting.pdf [https://perma.cc/BBD2-VG57] (last visited Nov.
(h) (i) to purchase, use, or accord a preference to, in its territory,
technology of the Party or of persons of the Party ; or
(ii) that prevents the purchase or use of, or the according of a
preference to, in its territory, particular technology, so as to afford
protection on the basis of nationality to its own investors or
investments or to technology of the Party or of persons of the
2. Neither Party may condition the receipt or continued receipt of
an advantage, in connection with the establishment, acquisition,
expansion, management, conduct, operation, or sale or other
disposition of an investment in its territory of an investor of a Party
or of a non-Party, on compliance with any requirement:
(a) to achieve a given level or percentage of domestic content;
(b) to purchase, use, or accord a preference to goods produced in
its territory, or to purchase goods from persons in its territory;
(c) to relate in any way the volume or value of imports to the
volume or value of exports or to the amount of foreign exchange
inflows associated with such investment; or
(d) to restrict sales of goods or services in its territory that such
investment produces or supplies by relating such sales in any way
to the volume or value of its exports or foreign exchange earnings.
3. (a) Nothing in paragraph 2 shall be construed to prevent a Party
from conditioning the receipt or continued receipt of an advantage,
in connection with an investment in its territory of an investor of a
Party or of a non-Party, on compliance with a requirement to locate
production, supply a service, train or employ workers, construct or
expand particular facilities, or carry out research and development,
in its territory.41
Paragraph 1 clearly restricts host countries from imposing any
performance requirements listed in sections (a) through (h). For
instance, section (a) says that the host countries should never ask
foreign investors to use a domestic supplier for a certain amount of their
supplies. As noted earlier, this prohibition is based upon the link
between foreign investment and trade: the capacity to enter a host state
should not be used as a means of distorting trade in goods.
41. 2012 US Model BIT, art. 8(1), (2), & (3)(a), https://ustr.gov/sites/default/files/BIT
%20text%20for%20ACIEP%20Meeting.pdf [https://perma.cc/BBD2-VG57] (last visited Nov.
Paragraph 2 imposes even stronger restrictions on host countries.
It prohibits a host country from imposing the performance
requirements listed in sections (a) through (d) of Paragraph 2, even if
the host country provides the investor with an “advantage” in exchange
for agreeing to the obligations. Here, the text does not define what
“advantage” means, but an investment arbitration tribunal constituted
under NAFTA has stated that an advantage may include tax incentives,
including tax holidays and the reduction of corporate income taxes.42
This prevents host countries from requesting foreign investors use
domestic suppliers for a certain amount of the production as indicated
in section (a) or any of the other performance requirements listed in
sections (b) through (d), even if the host countries provide tax
incentives such as tax holiday in return. Therefore, it is clear that the
US Model BIT 2012 strongly prohibits any of the performance
requirements with respect to sections (a) through (d) of Paragraph 2,
irrespective of the receipt of advantage by foreign investors.
Interestingly, the performance requirements listed in sections (a)
through (d) of Paragraph 2 are identical to those listed in sections (b)
through (e) of Paragraph 1. Then, what about the other sections of
Paragraph 1? Paragraph 2 is silent on whether host countries can
impose the performance requirements listed in sections (a), (f), (g), and
(h) on foreign investors in exchange for tax incentives. Consequently,
it can be argued that the US Model BIT 2012 permits host countries to
impose the performance requirements listed in sections (a), (f), (g), and
(h) of Paragraph 1 as long as they provide tax incentives to foreign
investors in return, meaning that the right to enact performance
requirements is conditioned on their connection to tax incentives. The
presumption here may be that any harm befalling the foreign firm
through the performance requirements is more than negated through
the granting of the incentive advantage. Similar provisions do not exist
42. See SUZY H. NIKIEMA, INT’L INST. FOR SUSTAINABLE DEV., PERFORMANCE
REQUIREMENTS IN INVESTMENT TREATIES 2 (2014) (explaining that tax incentives can
constitute an “advantage” under the performance requirements); see also Pope & Talbot Inc. v.
Government of Canada, Interim Award, ¶ 73 (Arb. Trib. 2000), https://www.italaw.com/sites/
default/files/case-documents/ita0674.pdf [https://perma.cc/5E9W-DNYQ] (last visited Nov. 1,
2017) (“It is common ground between the disputing parties herein, and the Tribunal agrees, that
the granting and maintaining of EB [Established Base] and/or LFB [Lower Fee Base] quotas to
exporters under the provisions of the ECR [Export Control Regime] is an ‘advantage’ within
the meaning of Article 1106(3).”).
in TRIM, which is relatively narrow in its focus on local content rules43
Paragraph 3 creates a straightforward exception to Paragraph 2,
and thus provides another opportunity for host countries to experiment
in establishing tax incentives and performance requirements through
their BITs. For example, host countries can, in exchange for tax
incentives for foreign investors, impose performance requirements that
are related to training local employees or carrying out research and
development works. What is given with one hand is taken by the other.
The reason that this kind of incentive coupled with a performance
requirement was not prohibited by the US Model BIT—or TRIM for
that matter—is self-evident. Such policies are not likely to cause
harmful distortions in world markets, and to the extent that they do, the
distortions are mutually self-extinguishing. Most importantly, they
should foster domestic economic development with minimal impact on
global economic relations. This logic is captured to some degree in the
language of the WTO’s Agreement on Subsidies and Countervailing
Measures (“ASCM”), which is the only international agreement that
effectively controls tax incentives taking the form of benefits granted
to trading firms. The ASCM prohibits host countries from granting
incentives for firms that produce goods aimed at the export market and
where global inefficiencies may result. If there is no clear contingency
on export, then actual harm must be demonstrated by the complaining
state.44 Likewise, Article 8(3) of the US Model BIT, which outlines the
types of performance requirements permitted when linked to tax
incentives, does not contemplate what might be considered distortive
activities. Foreign investors may be compelled to hire local workers
and to train them because, unlike goods, there is no free movement of
workers around the world, and therefore no taint on world markets.
Research and development financing, while potentially distortive, is
typically viewed as beneficial in the long run because the upfront costs
of such activities would make them inefficient if they did not receive
artificial state support in the early stages. In other words, not all tax
43. Local contents requirements are policies imposed by host governments that require
foreign investment firms to use domestically manufactured goods or domestically supplied
services in order to operate in an economy. See The economic impact of local content
requirements, Trade Policy Note, OECD,
https://www.oecd.org/tad/policynotes/economicimpact-local-content-requirements.pdf [https://perma.cc/6UBZ-DRT5] (last visited Oct. 24,
44. ASCM, supra note 20, art. 3 (injury to the domestic industry should be proven).
incentives and performance requirements are prohibited by BITs, only
those which threaten economic efficiency are disallowed.
In sum, host countries have full discretion to impose the
performance requirements listed in sections (a), (f), (g), and (h) of
Paragraph 1 and all performance requirements listed in Paragraph 3 in
exchange for tax incentives for foreign investors.
The use of tax incentives to attract FDI in the Republic of Korea
(“South Korea”) is illustrative of how these policies can be
implemented in tandem with performance requirements in an
economically productive manner. Indeed, the tax incentive offered by
the South Korean government in the 1970’s and 1980’s is a well-known
example of a “right” institutions.45 President Park Chung-Hee made
exports his top priority and greatly expanded the scope of export
subsidization. The exporters were provided with many tax incentives,
such as tax exempted and duty-free imports of raw materials. The
government implemented specific export targets for firms. A
noteworthy feature of the South Korean tax incentive system is that the
tax incentives applied not only to the final exporters, but to the indirect
exporters (firms that supplied the intermediate inputs used to produce
the final exports) as well.46 Most importantly, many tax incentives were
given to foreign investors in exchange for transfer of technology and
expertise. The foreign investors had to train local South Korean
employees to receive the benefit of the tax incentives. While the
exportoriented system would arguably violate TRIM today, the
employmentrelated tax incentive would not, and would almost certainly be
permitted under modern BITs modeled according to the US Model BIT.
It is worth noting that strong political stability through autocracy
is one of the major foundations for the success of all tax incentive
measures.47 Many government officers maintained almost daily contact
with major exporters and it is common for the minister of trade to
intervene in difficult situations. For example, to immediate customs
clearance for inputs being delayed. All tax incentives were monitored
and reviewed at a monthly trade promotion conference, chaired by the
president and attended by ministers, bankers and exporters.48 In short,
a country-specific tax incentive regime established by a strong
government is a good example of a right institution in tax incentive
Of course, other nations may have different types of right
institutions with different combinations of tax incentives and
performance requirements. This essay argues that developing countries
should first determine what types of tax incentives fit their local
economy and identify the appropriate performance requirements that
may be lawfully attached to the incentive measures. Simply put,
developing nations must examine and figure out what the right
institutions could be with respect to the combination of tax incentives
and performance requirements. A carefully tailored approach is
essential. Contrary to the regimes devised by the World Bank, the
conditionality policies of the IMF, and the dubious record of special
and differential treatment of the WTO, one size does not fit all. Once a
state ascertains the correct form for its tax incentive regime, it must
find way to arrange the measure to comply with the prohibitions on
performance requirements imposed by the BIT, as captured by
paragraphs 1, 2, and 3 of the US Model BIT. Depending on how the
state arranges the elements, it should be able to identify the requisite
policy space49 to carve out a country-specific form of the tax incentives
and performance requirements; the right institutions for a given country
and its unique circumstances. With an effective regime of tax
incentives in place, developing states may eventually find themselves
in a position where they can begin to gradually remove the tax
incentives because they have become naturally attractive to foreign
firms, thereby potentially extracting greater value in the long term.50
48. Rodrik, supra note 45, at 15-16.
49 . Most policy space arguments are about making provisions flexible by inserting
exception clauses or preamble language. Some arguments borrow methods from WTO’s
previous treatment for developing nations such as general exceptions or special and differential
treatment. See e.g., Suzanne A. Spears, The Quest for Policy Space in a New Generation of
International Investment Agreements, 13 J. INT’L ECON. L, 1037, 1071 (2010) (arguing that
general exception clauses, such as those found in IIAs, and preamble language expressing some
non-investment policy objectives, such as labor or environment protection, could provide more
50. Of course, the removal of tax incentives has been successfully challenged by investors
in investor-state arbitration, so host states are warned to act with full transparency. See generally
Micula S.C. v. Romania, ICSID Case No. ARB/05/20, Award (Dec. 11, 2013),
[https://perma.cc/TKZ3-7JLJ] (last visited Oct. 24, 2017).
Readers of this essay may be surprised to learn that experienced
negotiators from developed nations usually hold question-and-answer
(“Q & A”) sessions during the main investment negotiation phase to
facilitate the negotiation. This apparently shows the dramatic
inequality of bargaining power between the negotiating parties.
Negotiators from developed countries believe the Q & A session is the
only way to facilitate the negotiation; it is impossible to agree on any
terms during the negotiation due to the inexperience of the negotiators
for the developing nation.
Likewise, many BIT negotiators from developing nations do not
understand the mechanics of provisions prohibiting performance
requirements in exchange for tax incentives, nor do they appreciate the
nature of the obligations assumed under these treaties.51 Consequently,
they sign the BITs that restrict the use of tax incentives and
performance requirements that could actually represent the “right
institutions” in a certain stage of the development. This results in a
significant loss of access to policy instruments that help developing
countries continue their economic growth. Developing nations must
fully understand the interaction between tax incentives and
performance requirements and carve out these types of measures, if
necessary, during their BIT negotiations. Such strategies should
preclude the need for more monolithic reform packages imposed by
other Bretton Woods institutions, which, while well-intentioned, will
most likely be less useful in the long run.
51. For more information, see LAUGE POULSEN, BOUNDED RATIONALITY AND ECONOMIC
22. ALEX EASSON & ERIC M. ZOLT , WORLD BANK INSTITUTE, TAX INCENTIVES 3 ( 2013 ).
23. Id . at 10.
24. See generally Andrea Fosfuri et al., Foreign direct investment and spillovers through workers' mobility, 53 J . OF INT'L ECON . 205 ( 2001 ).
25. United Nations , Committee of Experts on International Cooperation in Tax Matters, Sixth Session, Secretariat Note on Agenda Item - Use of Tax Incentives in Attracting Foreign Direct Investment , E/C.18/2010/CRP.13, p. 18 ( Oct . 13 , 2010 ), http://www.un.org/esa/ ffd/tax/sixthsession/UseOfTaxIncentivesALL.pdf [https://perma.cc/RJ5C-2XAS] (last visited Oct . 24 , 2017 ).
26. Collins, supra note 18, at 9 (quoting C. WALLACE, THE MULTINATIONAL ENTERPRISE AND LEGAL CONTROL: HOST STATE SOVEREIGNTY IN AN ERA OF ECONOMIC GLOBALIZATION 326 (2d ed. 2002 )).
33. De Melo Vieira , supra note 17 , at 80 ( arguing that there are important differences between tax and investment treaties regarding their goals, persons/entities subject to the treaty, and protection obligations imposed on the investors. Most countries prefer to address international taxation issues in separate treaties to maintain maximum fiscal sovereignty. Although investment and tax matters are closely related, tax policies should not be driven exclusively by foreign investment concern).
34. PAUL B. STEPHAN, COMPARATIVE TAXATION PROCEDURE AND TAX INCENTIVE IN INTERNATIONAL INVESTMENT LAW AND COMPARATIVE PUBLIC LAW 600 (Stephan W . Schill ed., 2010 ).
35. Canada-Mongolia BIT , art . 16 ( 7 ), http://investmentpolicyhub.unctad.org/IIA/treaty /3698 [https://perma.cc/C72Q-MKEH] (last visited Nov. 9 , 2017 ).
36. See e.g., US-Uruguay BIT , art . 21 ( 7 ), https://ustr.gov/sites/default/files/uploads/ agreements/bit/asset_upload_file748_ 9005 .pdf [https://perma.cc/WCX7-CSZD] (last visited Nov. 9 , 2017 ).
37. Zeng Huaqun , Balance, Sustainable Development , and Integration: Innovative Path for BIT Practice, 17 J. INT'L ECON . L. 299 , 302 - 04 ( 2014 ) (“the model gives developed state a negotiating advantage, since the party who controls the draft usually controls the negotiation .”). Most developing nations are suffering from unequal bargaining power in the BIT negotiations because they have not drafted their own model BITs. Therefore, their position is merely accepting or slightly modifying a model BIT prepared by the developed country negotiating partner. Only a few developing states have prepared their model BITs and these are heavily influenced by the model BIT of developed countries) . See also M. SORNARAJAH, THE INTERNATIONAL LAW ON FOREIGN INVESTMENT 207-08 ( 2004 ) (arguing that it is hard to expect developing nations to have legal departments sophisticated enough understand and analyze the nuances in the variations in the terms used in BITs) .
38. See Huaqun, supra note 37 at 302-304.
39. TODD ALEE & MANFRED ELSIG, ARE THE CONTENTS OF INTERNATIONAL TREATIES COPIED AND PASTED? EVIDENCE FROM PREFERENTIAL TRADE AGREEMENT 1 ( 2015 ), http://wp.peio.me/wp-content/uploads/PEIO8/Allee,%20Elsig% 2013 .2. 2015 .pdf [https://perma.cc/2VB3-LWZ9] (last visited Oct . 24 , 2017 ) (explaining how the CanadaColumbia preferential trade agreement (“PTA”) is remarkably similar to the Canada-Peru Agreement) . In 2008 , Canada signed multiple annexes to Chapter 14 of the PTA regarding government procurement listing entities, goods, and services in Canada and Colombia covered by the agreement's procurement rules: These annexes that contain the “Schedule of Colombia” are unremarkable, until one realizes that the agreement in question is actually between Canada and Peru. Canada was indeed negotiating a PTA with Colombia around that same time, and would sign that agreement a week later. This odd insertion of language about Colombia in an agreement with Peru certainly appears to be the result of sloppy copy-and-pasting between treaties . Id. at 1.
45. See generally Dani Rodrik, Taking Trade Policy Seriously: Export Subsidization as a Case Study in Policy Effectiveness 15 (Nat'l Bureau of Econ . Research, Working Paper No. 4567 , 1993 ).
46. Id . at 14.
47. Dani Rodrik , Taking Trade policy Seriously: Export Subsidization as a Case Study in Policy Effectiveness , Working Paper No. 4567, NATIONAL BUREAU OF ECONOMIC RESEARCH 358 (Levinsohn et al, 1995 ).