Customary international law provides that when countries habitually adhere to certain norms because of a belief that customary international law requires them to do so, then those norms constitute binding international law. Note that the fact that countries adhere to certain norms is not sufficient to establish the existence of an international obligation. For a usage to become a custom, it must be shown not only that countries habitually act (or refrain from acting) in a certain manner, but that they do so because of their belief that they are so obliged under international customary law. Once a custom has been established, it is binding upon all countries, including countries that did not take part in creating it and countries that did not even exist when the customary norm was established.
The other source of international obligations is conventional international law, which provides that countries are bound by the term of treaties to which they are signatories. On occasion, customary and conventional international law overlap.
Certain treaties have been recognized as declarative rather than constitutive, as codifying customary international law rather that creating new norms. In such a case, the treaty will effectively bind even non-signatories. One example of such a treaty is the Vienna Convention on the Law of Treaties, the “meta-treaty” that governs the validity and interpretation of treaties. Because the Vienna Convention is considered a codification of pre-existing customary international law, even those countries that have not signed it, such as the United States, are effectively subject to its terms.
There clearly exists conventional international tax law, embodied in the over 3,000 tax treaties currently in force. Once signed and ratified, such treaties restrict the taxing power of signatories, and imposing tax in a manner inconsistent with the terms of the treaty constitutes a breach of an international conventional obligation. (Whether tax provisions that violate the treaty are valid under domestic law is not a question of international law, but of domestic law. For instance, under US Constitutional law, Congress may override a treaty provision by subsequent legislation. Although such an override constitutes a violation of an international commitment undertaken by the United States and is prohibited by the Vienna Convention, the override is nevertheless valid as a matter of U.S. domestic law.)
The intriguing question that Professor Avi-Yonah raises in this chapter is whether there also exists a customary international law of taxation. As noted, to prove the existence of such customary international norms it is not sufficient to show that countries habitually abide by certain principles in their tax systems or that the terms of tax treaties to which they are signatories are substantively similar (according to the author, treaties are about 80% identical to each other). This merely proves a usage. To prove a custom, it is necessary also to demonstrate that countries abide by certain principles of taxation because of a belief that they are obliged to do so under the terms of customary international law.
The task that Avi-Yonah takes upon himself – to prove the existence of a customary international tax law – is clearly not an easy one. To make his case, he refers to four different instances in which countries have designed their tax system in such a way as to avoid violating a customary international norm. This, he claims, demonstrates that countries recognize the legally binding force of those norms. For example, in 1937, Congress enacted legislation to deal with some of the tax problems that arise from the fact that corporations have a legal identity separate and distinct from their shareholders. With regard to domestic corporations, it provided that “personal holding companies” (PHCs) be taxed at the individual rate (which was then, as today, much higher than the corporate rate). It also provided that U.S. resident shareholders of “foreign personal holding companies” (FPHCs) be taxed as if they had received a dividend from the corporation even though dividends were not in fact distributed. Avi-Yonah posits that the difference between the two regimes derives from the fact that PHCs were domestic, while FPHCs were foreign, and that Congress was of the belief that under customary international law it did not have the jurisdiction to tax the income of foreign corporations. It therefore focused its attention on the FPHC’s U.S. resident shareholders. However, since the 1960s countries have expanded the reach of their controlled foreign corporation (CFC) rules. Avi-Yonah argues that this represents an evolution of customary international tax law and that countries are now permitted to impose tax on corporations that earlier customary law would have ruled to be outside of their taxing authority.
With regard to other issues of international taxation, he offers evidence that the permanent establishment threshold, the arm’s length standard, and the prohibition of non-discrimination against foreign nationals are also part of customary international tax law.
Having stated and substantiated his case, Avi-Yonah then asks whether the existence of a customary international law of taxation has any practical significance. The ostensible problem is that in the United States, federal statutes that contradict customary international law are nonetheless valid for the purpose of domestic law. Avi-Yonah therefore suggests a number of instances in which recognizing the existence of a customary international law of taxation may have practical ramifications. First, outside the United States tax controversies are occasionally adjudicated by international arbitration tribunals, which could prefer the norms of customary international law to domestic legislation. Second, as regards U.S. federal taxation, courts could rely on the norms of customary international tax law where there exists no explicit federal legislation. Third, with regard to state taxation, customary international law is equivalent to a treaty and therefore is binding upon the states under the Supremacy Clause of the U.S. Constitution.
The views expressed by Avi-Yonah in this chapter are far from uncontroversial. While acknowledging that there is a great degree of commonality among the tax practices of the various countries, other scholars have expressed the opinion that such usage does not rise to the level of custom. Similarly, while there does exist a view that customary international law is self-executing in the United States (that it could be used to invalidate state legislation, that it could be relied upon in the absence of explicit federal legislation, or even that it could override previously enacted federal legislation), in practice the courts have not adopted such a view.
Nevertheless, this is not the first time that Avi-Yonah has moved ahead of the pack in the field of international taxation. Whether or not in this instance the pack will follow is, of course, a matter of speculation. In any case, as the world becomes more and more integrated and the tensions surrounding the interplay of different countries’ tax systems becomes more pronounced, the idea that there is an international customary law of taxation is a fascinating concept and deserves to be the subject of future discussion.