Arbitration, Review of

• Author: International Law Group

Marvin Ray Feldman Karpa (taxpayer) is a citizen of the United States who owns and operates an export business in Mexico called Corporacion de Exportaciones Mexicanas S.A. de C.V. (CEMSA). CEMSA was buying cigarettes from volume retailers such as Wal-Mart and Sam's Club within Mexico and selling them to customers outside Mexico.

Impuesto Especial Sobre Produccion y Servicios (the "Special Tax on Production and Services" or IEPS) applies to the manufacture and sale of cigarettes. If a cigarette business exports certain products, such as cigarettes, subject to the IEPS tax , the Mexican government may give rebates to the exporter. To obtain the rebate, however, the exporter has to produce invoices that "separately and expressly state the amount of the IEPS tax paid".

From time to time, CEMSA applied for the tax rebates and the Mexican government generally granted them. Mexico later changed its approach, however, and refused to pay CEMSA the tax rebates; it claimed that CEMSA could not come up with invoices that separately set forth the amount of the tax paid.

Apparently what happened was this. Cigarette manufacturers declined to sell to CEMSA and other exporters; leading CEMSA to buy its cigarettes from volume retailers (VRs). The invoices sent to CEMSA by the VRs, however, did not separately list the tax because the makers had already paid it before selling the cigarettes to the VRs. As a result, the price paid by CEMSA for cigarettes included the tax, but the tax portion did not show up on the invoices gotten from the VRs.

In 1998, the Mexican Taxation Agency, the Secretaria de Hacienda y Credito Publica (SHCP) audited CEMSA. The SHCP decided that CEMSA had incorrectly received IEPS tax rebates between January 1996 and September 1997. SHCP demanded repayment of about US $25 million. The audit also alleged that CEMSA had flagrantly overstated the amount of the IEPS tax it had paid.

In April 1999, CEMSA filed a notice of arbitration at the International Center for Settlement of Investment Disputes (ICSID) in Ottawa pursuant to Chapter 11, Article 1120, of the North American Free Trade Agreement (NAFTA). The tripartite tribunal had members from Greece, the United States and Mexico.

In its application, CEMSA asked for damages roughly equivalent to US$ 50 million and raised three arguments. Most importantly, CEMSA maintained that Mexico's refusal to pay it the IEPS rebates constituted a violation of NAFTA article 1102 requiring that Mexico grant to investors of another party to NAFTA treatment no less favorable than it affords to its own investors. After a hearing, a majority of the tribunal held that Mexico had breached Article 1102 on "national treatment." The tribunal saw no merit in the...