Legislative Analysis

            To secure the passage of the R&D tax bill we need to ensure that there will be enough support at all levels of Government: the Sub-Committee on Industrial, Commercial and Brazil Cost Policies; the Committee of Economics, Industry and Commerce; the Chamber of Deputies; the Senate; and the President. 

            The following table shows the support that Fernando Henrique Cardoso’s government currently holds in the Chamber of Deputies and in the Senate: 

Therefore, we can see that the government holds a slight majority in both Houses.[1] And since the Committees have proportional party representation, we can expect similar proportions of support for the government at those levels as well. However, although it may seem that majority support already exists for the government, other factors affect the actual turnout of voting, like: absenteeism, travel, illness and other engagements. Therefore, the government coalition still needs to struggle to collect enough votes for passing their mandates. It should be noted that absenteeism is a predominant event in Congressional voting. Parties often use this to their advantage to ensure that their bills are passed by choosing voting schedules that conflict with the agenda of most members of their opposition party. It is not uncommon for significant bills to be voted on a late Friday afternoon. 

            The following table shows how the different parties are likely to vote on the R&D tax bill: 

Sub-Committee on Industrial, Commercial and Brazil Cost Policies 

This Sub-committee is composed of 20 members, presided by Mr. Márcio Fortes (PSDB). There are 11 members of the government’s coalition. However, there are some members of the opposition who are likely to support our R&D tax bill. These are the Deputies of the most economically powerful states in Brazil (São Paulo, Rio de Janeiro, Minas Gerais, Rio Grande do Sul, and Santa Catarina). Assuming that these members are willing to support the bill, there should be approximately 14 votes. 

Committee of Economics, Industry and Commerce 

This Committee is composed of 50 members, presided by Deputy Marcos Cintra (PFL). There are 27 members who belong to the government’s coalition. And after taking into account the members of the opposition from the economically most powerful states, the number rises to approximately 37 votes in favor of our bill.

Chamber of Deputies 

Deputy Aécio Neves (PSDB) is the president of the Chamber. As mentioned above, the government’s coalition has approximately 308 votes at this level. And if we were to take into account the more probable support from the Deputies representing the economically strongest states, we would get a total of 384 votes.

Senate 

In the Senate of 81 members, the government’s coalition has 53 votes. The current Senator presiding is Mr. Jader Barbalho (PMDB). Assuming that the Senators representing the most economically developed states will support our bill, the government’s coalition will be at roughly 62 votes.

President 

There should be little opposition at this level for approval of the bill, considering that we have three Ministries who will be pushing relentlessly for the R&D tax bill. By the time the bill reaches the President, he should have already been well informed of its benefits and existing broad support for it. 

Legal Analysis 

Domestic Laws 

            The law of Proex ensures that either loans or equalization financing is provided to exporters requesting it, provided that the applicant follows the proper procedure.  As a member of the WTO, Brazil is required to oblige by its rulings, and so there are no legal obstacles to changing Proex to the required conditions. The Itamaraty has the legal right to demand the changes be made to Proex by the CAMEX agency. CAMEX, together with SECEX, would be responsible for making the appropriate changes to Resolution No. 2.214 (Nov. 1995), which stipulates the most recent rules of Proex. The changes set by the Panel have already been made to Proex, thereby turning it into Proex III. A WTO review body must still evaluate Proex III before the Panel accepts it. If and when it gets approved, all the agencies related to Proex (like the Bank of Brazil, ‘Banco do Brasil’) will be informed, and they will make the appropriate changes. 

            In order to make further changes that go beyond the requirements of the Panel, as may be necessary after negotiations with the Canadians, CAMEX must be convinced of the need to redesign the export financing system. CAMEX can then redesign the program, after the changes have been approved by Congress. The following pieces of legislation are specific to Proex: 

·       ‘Lei No. 10.184’ (July 1999):  the main legal instrument regulating Proex, specifying the concessions and restrictions of the export-financing program.  If further changes are to be made to Proex III, this Law will need to be amended accordingly and approved by Congress. Subsequently, CAMEX can direct the related agencies to act according to the new Law. 

·       ‘Carta Circular BACEN nº 2.881’ (November 1999): instructs the Bank of Brazil of the interest rates for the Proex equalization system. This Letter was prepared by the Central Bank and is directed at the Bank of Brazil, which carries out the logistics of Proex. So a new circular letter will need to be written when the proposed changes are made to Proex III. 

·       ‘Portaria MDIC No. 374’ (December 1999):  lists the goods eligible for Proex financing. This list will not be affected, and so must be left unchanged. 

·       ‘Portaria Interministerial MF/ MICT nº 314’ (December 1995): regulates how Proex applies to services. This too will be left unchanged. 

·       ‘Resolução No. 2.799’ (December 2000):  defines the criteria for Proex financing of aircraft exports. The applied interest rate will need to be calculated with each operation, based on the CIRR. 

            The proposed R&D tax bill has to fit with the existing tax credit rules and IT Law.  The ‘Program of Industrial Capacity Building Support’ (PACTI) has Law No.9532 (Dec. 1997)[2] that accounts for fiscal incentives related to research and development. However, Law 9.532 is very limited in its scope and nature, and my proposal will have to be reconciled with it. Considering that my proposal grants more benefits than this Law, my proposal may replace it completely, or some of its clauses may be placed into my proposal.  Specific exemptions will have to be written into my proposal for the IT and oil sectors, in order to avoid conflict with existing laws governing these sectors. Once passed, the R&D bill should last for a certain period, probably between 5 to 6 years, after which time it has to be voted in Chamber to be extended. 

There is a method that the executive agencies can use to pass a piece of legislation in a matter of days, in order to avoid the parliamentary process altogether. By using a Provisional Measure (‘Medida Provisoria’_ MP), the bill is passed almost immediately in Congress because it does not need to be reviewed by the Deputies or Senators. MP’s are meant to be used only in times of national emergencies, such as when a natural disaster strikes a region, or the country is attacked. However, President Fernando Henrique Cardoso has used MP’s regularly to pass his policies, thereby making them very controversial. The only downside to using MP’s is that they have a duration of one month, and so must be reissued monthly to prolong the piece of legislation. This has resulted in a lot of administrative work for the President’s staff who must constantly reissue MP’s for the numerous Laws proposed by the President. Considering the controversy behind the use of MP’s I recommend using the normal legislative procedure through Congress. 

A duration of 5 years for the bill will allow it to be terminated or modified if external pressure, such as from a Free Trade Agreement with the EU or the Hemisphere (FTAA), is exercised on this R&D policy.  However, if the government manages to keep this policy and wants to extend it, the bill will be open to extension, should the government decide in favor of it upon its expiration. 

International Laws 

            The DSB Panel had a difficult time interpreting Proex because of the uniqueness of the financing system. While Proex’s loan type of was simple to interpret, the equalization type was harder because the benefits are not accrued directly by the seller or the buyer. In fact, the question was raised of whether there were any benefits at all to either party engaged in the trade. The WTO has the following interpretation: A government loan is not considered as conferring a benefit unless there is a difference between the amount that the firm receiving the loan pays on the government loan and the amount a firm would pay on a comparable commercial loan.[3] 

However, the first decision by the Panel was that Proex did grant benefits that were illegal, and so the Panel ordered Proex to be banned.  The Panel found at a later date, however, that Proex could be maintained as long as it was redesigned to fit international standards, such as OECD standards (see background section). 

            The Panel also evaluated and ordered the Canadian subsidies to be changed. There are still other subsidies that are under investigation, like the EDC or the Province Quebec. The evaluation process is being delayed by the Canadian government who has not provided sufficient information to the Panel, claiming that the financing programs are exempt from the ‘Information Access Law’ restricting the disclosure of data regarding the loans to the public. 

            Brazil has ‘developing country’ status in the WTO, meaning that it could invoke Article XVIII to request that this export promotion policy of Proex be exempt from WTO rules. In fact Brazil did request this exemption, however, the exemption is only granted for 8 years after WTO rules came into place. Hence, the transition stage has already expired.  There is another rule in the ASCM that would negatively impact the Proex.  This rule states that if a product is competitive (i.e. if it has over 3.5% of world market share for 2 consecutive years), then no subsidies are permitted for that nation’s sector. 

            The DSB Panel rulings on Proex by did not satisfy the Brazilian government because the Panels ruled Proex to be a subsidy for gaining an unfair advantage over other international competitors. Despite the Brazilian trade delegation’s reiteration of the original and existing purpose of Proex, from the point of view of the WTO Panel, Proex was considered illegal because it offered benefits to Brazilian exporters. The Brazilian delegation, however, will continue to push for their interpretation of the export subsidy, though it remains uncertain how long it will take for them to convince the Panel that Proex simply levels the playing field in terms of interest rates offered on loans to foreign buyers. It would be more beneficial for Embraer  to tackle the dispute through alternative strategies in cooperation with the Brazil government. , One possible strategy is the proposal outlined in this paper. 

            Canadian representatives are dissatisfied with the initial changes to Proex because there is no procedure guaranteeing that the changes have met the DSB requirements. Indeed, this "revealed a gap in the DSU, because there were no provisions to deal with a situation where a country introduced new measures and claimed compliance after 21.5 Panel had already rejected earlier efforts to show compliance."[4] Had there been a procedure to account for this situation, the Canadians could get an objective judgment by the DSB on compliance of the new Proex to the requirement as stipulated in the last report (WT/DS46/R). 

            The Panels ruled the Canadian subsidies, the Canada Account and Technology Partnerships of Canada (TPC), to be illegal according to the ASCM. This ruling led Brazil to continue challenging the Canadian subsidies with the hope that the DSB would also order the remaining subsidies to be changed or removed. The Brazilian government has already mentioned that it intends to challenge the Export Development Canada (EDC) program, which the Panel left out of its last rulings. The panel did not decide anything because there was a lack of information on the program. The Canadian government refused to supply information, claiming that such information was corporate and too secret and sensitive to be brought into the case. Although the Brazilian government, and the Panel itself, questioned the reasoning presented by the Canadian government, discussion on the matter was temporarily brought to an end. It is the intention of the Brazilian government and Embraer to analyze and evaluate the EDC in detail. Further, the Brazilian government has stated that it will investigate the loans made by the Crown Corporation to Bombardier, which the government of Brazil suspects to be at cut-rate levels.  In addition, Embraer said that it will challenge other subsidies that it claims have benefited Bombardier including the Canada-Quebec Subsidiary Agreement on Industrial Development, and the Sociéte du Development Industriel du Quebec. 

            From the perspective of the WTO/GATT, there is nothing to prevent the Brazilian government from granting tax incentives to companies on investments in research and development. From a legal perspective, therefore, the only barrier to implementing my proposal is Brazilian legislation.  However, under the WTO/GATT, no preferential incentives should be given to specific sectors of the economy. Article 8.2 (b) of the ASCM, however, allows special incentives for regions of a country that are economically disadvantaged, if a nation has a policy to develop that region.[5] My proposal will benefit all industries at one level, and the transportation industry at a higher level. The question therefore is if the WTO would consider the higher tax credit for R&D to the transportation industry as an incentive that benefits a specific sector, and thus illegal according to the WTO Agreement. In theory, the WTO should not rule the incentive to be beneficial to a specific sector because the transportation industry is comprised of several sectors. 

            Further, there is reason to believe that since the WTO has not yet challenged the existing IT Law No. 8.248/91, which grants tax benefits to IT companies investing in R&D, they should not have any basis to challenge the proposal for the transportation sector. 

            The part of my proposal for all sectors should not meet any legal challenges, considering that many developed countries already offer such tax incentives for investing in R&D through tax credits. The G8 countries all offer such tax credits, with only slight variations in the credit levels granted.[6] A study shows that Canada has the most beneficial R&D tax incentive program of all of the G8 nations.[7]

  Recommendation  

            My recommendation is for Embraer to campaign for a new tax law that grants tax credit to companies investing in research and development. The law will be two-tiered; one is specifically for the transportation industry, and the other for all other industries of the economy. Meanwhile, the Brazilian government will negotiate with the Canadians to push for reforms to Canadian subsidies to the aerospace industry, on condition that Proex is modified according to the requirements set forth in the DSB Panel decision. 

            A law granting tax credit on R&D investments will reduce the taxes owed by Embraer, thereby allowing it to compensate for the more limited version of Proex that will become available. Embraer can therefore prepare itself for the unfavorable conditions, without suffering too large an impact from the loss of global jet sales. Also, it gives more leverage to persuade the Canadian government to change its subsidies that now benefit Bombardier.

Comprehensive Strategy 

            The strategy will require building a coalition of domestic supporters of a tax law for research and development. This coalition will then begin a campaign called “Research and Development for Brazil’s Future” which will gain support of other groups to pass the proposed Law.  The coalition will work on three strategic areas: legislative, institutional and media. Internationally, Embraer will convince the Ministry of Foreign Relations to negotiate and persuade their Canadian counterparts to agree to modify their subsidies according to any future WTO/DSB rulings. While both strategies are of similar importance, in order to achieve the overarching goal of resolving the subsidies dispute, the R&D bill needs to be passed in Brazil in order to allow for Brazil’s trade representatives to negotiate more effectively with the Canadians to resolve the whole case. 

International Strategy 

Objective:  To convince the Canadian government to modify their subsidies so as to meet international standards as specified by the WTO/DSB. 

Cooperating with the Ministry of Foreign Relations 

At the international level, the most important way that Embraer can be engaged is to help resolve the ongoing subsidies dispute by providing information to fortify Brazilian diplomats’ arguments. Embraer has already been supplying financial information regarding the use of Proex for its exports to the Ministry of Foreign Relations since the Ministry first began meeting with the Canadian government. The company should continue to do so, and also research more thoroughly the details of the subsidies given to Bombardier. Economic studies demonstrating how the economic conditions in Canada provide better selling terms to exporters compared to the Brazilian context would be useful. This kind of research would put the Brazilian trade delegation in a much better position to argue its case that Proex does not grant any real benefits to Embraer ’s customers; and also that the Canadian government financing programs function as subsidies for Bombardier. 

            Embraer should also recommend a strategy to the Ministry of Foreign Relations that should end the subsidies dispute with Canada. Brazilian trade representatives can argue that since Proex is being changed according to the international requirements set out by the DSB, it is expected that the Canadians also comply and redesign their subsidies.  Embraer’s proposal would be for the Brazilian trade diplomats to meet with their Canadian counterparts and explain that if the Canadian government agrees to have all their subsidies going to the aircraft industry properly investigated by the DSB Panels, then the Brazilian government will change Proex as requested by the Canadians coupled with the condition that both sides agree to implement the DSB Panels’ restrictions. The recommended negotiation process is outlined in the following section.
   

Recommended Negotiation Process

        Assuming the Canadians agree to the proposal

 
Negotiation Strategy 

            The Brazilian trade delegation will be entering negotiations that have existed since 1996.  These longstanding negotiations will present a drawback because strong emotions have developed amongst the delegates, thereby shifting them towards a positional bargaining approach, which reduces the possibility of compromise. On the other hand, the long duration has caused both sides push harder to end the case.  At any rate, the Brazilian delegation will need to approach the Canadians with an attitude towards reaching a compromise that satisfies the international community and export financing norms. 

            One aspect that must be clarified to the Canadians is the mounting support among developing countries to taking a critical stance regarding developed nations’ subsidies. It has become increasingly apparent to developing countries that subsidies in the developed world are hampering the potential for poorer countries to increase their exports due to the trade distorting effect.  The protests at Seattle’s WTO Ministerial in 1999 inolved this issue, and informed the world of the hypocrisy in the liberal rhetoric from developed nations. Since that time, a growing number of economists, NGO’s and politicians have condemned the inherent hypocrisy of developed nations.  This movement is strengthening the developing countries’ position within the WTO in arguing for greater pressure on developed members to phase-out their subsidies, in the interest of having a working international trading system, which is the essence of the GATT/WTO. 

            The EDC provides financial support to companies of all sizes, especially smaller companies, and so the Canadians will be concerned about the effect on their Small-to-Medium Enterprises (SME’s). However, it is only the loans given to the larger companies, like Bombardier, that concern the Brazilian delegates. Therefore, the Brazilian delegation should propose that only the financing terms of loans to large businesses should be modified according to DSB rules. This would make it more feasible for the Canadians to accept expediting the review of the EDC in the WTO in order to analyze its legality. 

            Support can be gained from NGO’s that work towards increasing transparency in institutions, companies and governments. Transparency International (TI) is the main NGO in this field, and they should be approached to ask that they investigate the EDC and other Canadian export subsidies. TI works at all three levels, corporate, institutional, and government, therefore they will be effective in demanding greater transparency of the EDC, at all levels. In Canada the ‘EDC Working Group’, a coalition of Canadian human rights, labor, environmental and development organizations, has called on the federal government to require EDC to adhere to binding social and environmental assessment standards. They have proposed that Canada push at the international level for all export credit agencies to adopt the World Bank standards as a minimum, particularly in the area of disclosure.[8]  By proposing this idea to Canada, the Canadian delegation will need to realize that complying with World Bank standards on disclosure will give the impression to the rest of the world that Canada is willing to improve their export financing conditions as well as international export financing conditions.  The argument for disclosure can be presented to the Canadians with findings from research that shows that “the disclosure obligations placed on World Bank, U.S. and other international financing agencies have not harmed the commercial interests of these agencies' clients - including many of the companies EDC services.”[9]  Additionally, the Brazilian delegation can tell their counterparts that if progress is not made on the issue soon, that they will pressure the WTO to accept NGO input in the dispute settlement procedures so that the input can be used as legitimate information for legal arguments. Considering that there are many more NGO’s who oppose EDC, than support it, this move would surely offset the Canadian arguments. 

            If the negotiations do not look promising up to this point, then the Brazilian delegation will have to remind the Canadians that trade retaliation, in the form of raised tariffs, will be much worse for Canada than Brazil. As stated above, Canadians export a lot more to Brazil than vice versa, and so if the DSB grants the Brazilians the right to retaliate, due to the illegal export financing by the Canadians for Air Wisconsin and Northwest, then a greater threat can be made to the Canadians. 

            The Canadian delegation will be reluctant to modify their export subsidies because of the importance they have on the Canadian companies’ export performance. Considering that the Canadian economy relies heavily on exports, it can be expected that the negotiators will be under a lot of pressure not to change the legislature on the subsidies.  Both sides will have to negotiate the possibility of restricting the future budgets of their own subsidies. By placing such restrictions, the parties show that they are taking a proactive approach to removing these subsidies.  Even though the Brazilian side may propose that both sides remove all their subsidies as an agreement, the Canadian delegation will prefer some form of compromise that preserves as much of the export subsidies as possible.  Therefore, the Brazilian delegation should prepare certain reforms for both sides’ subsidies to be accepted and carried out within a certain time period.  The Brazilian delegation can propose that Proex III will be changed to Proex IV, which includes an ‘exposure fee’. At the same time, they should propose to the Canadians that they reform the EDC, Invest Canada, and Province of Quebec, to a point where they are in line with international norms, and are transparent to society. The Brazilian delegation may propose what specific international norms should be applied, however the Canadian delegation may prefer to have the DSB decide, in which case the Brazilian delegation may have to agree to have the DSB determine what changes are necessary to the Canadian subsidies. On the basis that all arguments above have been made by the Brazilian delegation to the Canadian side, it is likely that the Canadians will be willing to reach an agreement on how to reform their export subsidies.

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