The need for reform and the Transfer of Competency Agreement

The fiscal limitations imposed by Annex 4 on the BiH level as summarised above clearly demonstrated the need for reform. This reform led to the first transfer of competency agreement from the Entities to the BiH level under Article III.5(a) of Annex 4.

A summary of the reform process that was followed which led to this transfer agreement needs to be set out as this forms a vital part of this commentary. Without this, the current Constitutional framework cannot be understood. In addition, key factors that indicated the need for this reform have been mentioned to facilitate understanding.

From the fiscal perspective, the Entities and the Brčko District functioned as if they were sovereign states. Each set its own tax rates for direct taxation (income tax and corporate tax, social security) and for indirect tax (sales tax, excise taxes). Only customs rates and duties were unified across BiH.

This allowed each area to compete for revenues. For example, part of the indirect tax regimes included a separate charge imposed on petrol and diesel. The Brčko District did not impose two of these, causing citizens from both the RS and the Federation who lived near its borders to divert their shopping patterns, adding to the Brčko budget and reducing amounts in those of the Entities. The RS also had a lower sales tax rate on certain items that arguably distorted consumer patterns. While customs rates were the same, as each area had its own administration, different interpretations of categories and types of goods could easily cause differential rates to be charged across BiH for the same types of goods. The area into which goods were destined received the customs revenue.

Those goods subject to excise taxes (tobacco, coffee, alcohol, petrol, etc.), when manufactured or imported into one area, and sold to consumers in another area, would be subjected to this tax twice. This acted as an illegal barrier to inter- Entity trading and was a disincentive to compliance.³⁸⁸⁵

It had essentially proved impossible to harmonise either laws across the fiscal areas and often, more importantly, interpretation, implementation and application of these laws. Proposals and suggestions for a dual-Entity value added tax (VAT) system made by both the RS and IMF were rejected as unworkable by the OHR- chaired International Advisory Group – Taxation (IAG-T).³⁸⁸⁶

The International Community had been well aware of these issues and wanted to ensure real progress was made. The three-way indirect tax system clearly had to be removed, and with appropriate coordination, the International Community, through the OHR-chaired IAG-T, came to a unified stance that there should be one Administration for all indirect taxes across BiH and one legal system that regulated this (BiH level).

International Community lobbying of the Ministries of Finance and their relevant domestic counterparts led to an understanding and acceptance of core principles of negotiation which were set out in a High Representative Decision of 12 February 2003 entitled “Decision Establishing the Indirect Tax Policy Commission”.

This Commission worked from March until August 2003 and was tasked with drafting legislation set out in Article 2, specifically:

a) the merger of the separate customs administrations in Bosnia and Herzegovina into one single customs administration of Bosnia and Herzegovina;

b) the establishment of a single State-wide value added tax;

c) the establishment of an Indirect Taxation Administration (ITA), that should operate at the State level, include the single customs administration and be responsible for the collection and administration of indirect taxes, including customs duties and value added tax;

d) A single account for collection of all BiH indirect tax revenues.

The Commission drafted two pieces of Legislation, the “Interim Law on Merging the Customs Administrations and Establishing the Indirect Tax Authority” and the “Law on the Indirect Taxation System in Bosnia and Herzegovina” (ITA Law).

The Interim Law was adopted to allow the initial commencement and preparatory work to commence and politically was a first tentative step along the reform process. It allowed for the institution of the Indirect Tax Authority to exist in 2003 so that it could be included in the BiH Budget for 2004. This law was also considered constitutional as Annex 4³⁸⁸⁷and the Entity Constitutions did not prevent a BiH-level customs administration from operating as long as revenue flows were not altered.

For the adoption of the ITA Law to take legal effect required the transfer of competency agreement under Article III.5(a) of the Constitution of Bosnia and Herzegovina.

This transfer agreement³⁸⁸⁸ sets out the following:

1. In accordance with the Constitution of Bosnia and Herzegovina the Entity of the Federation of Bosnia and Herzegovina and the Entity of the Republika Srpska hereby give their consent for responsibilities regarding their indirect taxes, including issues concerning administration to be transferred to the institution of the State of Bosnia and Herzegovina.

2. The mentioned allocation of competencies shall, among other things, comprise competency for making and implementing the policy of indirect taxation in Bosnia and Herzegovina as well as the collection and distribution of indirect taxes.

3. Bosnia and Herzegovina shall assume the competencies that the Entities transferred to it.

4. While establishing the institutional and organisational basis for a unique system of indirect taxation, Bosnia and Herzegovina shall be obliged to ensure that the policy of indirect taxation is determined by the Steering Board, comprising of representatives of Entity Governments.

The actual mechanics of transfer under Article III.5(a) of the Constitution of Bosnia and Herzegovina are beyond the scope of this commentary on Article VIII; however, it was effected by parliaments in both Entities approving the transfer agreement.³⁸⁸⁹

The significant aspects of the transfer agreement are that responsibility for the Entities’ indirect taxation are all transferred to the BiH level (administration, collection, distribution) but with regard to indirect taxation policy, the BiH level is required to ensure that this policy is determined by a “Steering Board” comprising representatives of the Entity governments. This Steering Board effectively means that a “dual key” system was established for determining and setting indirect taxation policies. These are set out in the Law on the Indirect Taxation System of Bosnia and Herzegovina (ITA Law), which is referred to below.

It must also be noted that Brčko did not participate in the transfer of competency agreement. Legal analysis and the prevailing legal views³⁸⁹⁰ at the time noted that Article III.5(a) refers only to Entities making agreements, not a District or any other level of government, meaning that Brčko was not able to participate. Additionally, an analysis conducted of the Brčko Final Award³⁸⁹¹ observed that Brčko was awarded competencies that lay at the Entity level. Logically, if such competencies were no longer at the Entity level, Brčko could no longer have these as it would then exercise more competencies than those of the Entities.