611.6131/538

Memorandum by Mr. George F. Kennan of the Division of European Affairs

A situation has arisen with respect to the customs treatment of Soviet coal entering this country which may well jeopardize the prospect of obtaining renewal on terms satisfactory to us of our commercial agreement with the Soviet Union. The circumstances are as follows:

When we negotiated in the summer of 1936 a renewal of our annual commercial agreement with the Soviet Union14 the Russians refused to increase the total amount of their intended purchases for the coming [Page 602] year. Their reason for such refusal was that we were not able to make arrangements under which their coal entering this country would be exempt from the discriminatory excise tax of ten cents per hundred pounds laid down in section 601 (c) (5) of the Revenue Act of 1932.15 They asked, during those negotiations, that there be included in the agreement most-favored-nation clauses similar to those included in the ordinary trade agreements, in order that they might be in a position to claim exemption for their coal on the grounds that “treaty provisions” envisaged such exemption. We refused to accede to this request, stating that in our opinion an agreement of this nature would not, in view of the wording of the Revenue Act, be considered to be a treaty and would thus not entitle their coal to the desired exemption.

A couple of months later (in September 1936) the Treasury issued a decision exempting Dutch coal from the operation of the tax16 on the basis of the Netherlands trade agreement,17 which contained most-favored-nation clauses similar to those requested by the Russians. This was quite embarrassing to us since the Russians claimed that they had been let down and that if we had given them most-favored-nation treatment as they had requested their coal would have been exempted from the duty just as the Netherlands coal had been.

When the question of the renewal of the agreement again came up in the summer of 1937 the Russians used this argument with considerable effect and again asked for most-favored-nation treatment. A compromise was finally worked out whereby we agreed to give them the most-favored-nation clauses and assured them that the Treasury would hold that Soviet coal would thereby become exempt from the tax, this holding, however, being subject to possible adverse holding by the courts. In return they increased the promised amount of their purchases from thirty to forty million dollars and undertook to export to the United States not more than 400,000 tons of coal during the agreement year. By obtaining this limitation of the amount of coal which they would export to this country, we hoped to protect the interests of the American coal producers and to eliminate further trouble with regard to this tax.

This last commercial agreement entered into effect on August 6, 1937 and was to run for a year. Up to the present time, i. e., during well over half of the agreement year, it is our understanding that only approximately 100,000 tons of Russian coal have been imported. Imports for the entire year will presumably not exceed 200,000 tons.18 [Page 603] Actually, the American importers are better off at present, when no tax is being levied on Russian coal, than they were in the days when this coal was dutiable. In 1936, for example, imports from Russia amounted to slightly over 400,000 tons.

Nevertheless, a number of the American producers have now gotten together and requested information from the Treasury Department as to the classification and the rate of duty assessed on this Russian coal. In accordance with established procedure, the Treasury subsequently announced that beginning with May 21 any Russian coal entering this country will, if challenged by protest under section 516 (b),19 be subject to the decision of the United States Customs Court with regard to the applicability to it of the excise tax.

It is obviously the intention of these domestic coal producers to challenge the entry free from the excise tax of Soviet coal. It will be several months, if not indeed one or two years, before the case can be finally settled in the courts. Meanwhile, beginning with May 21 of this year, the Russians will not know whether the coal they are importing into this country will or will not eventually be subject to the excise tax.

The Soviet Embassy has already evinced considerable concern at this state of affairs, and it is evident that the uncertainty which will now prevail with respect to the levying of a tax on what is in the Russian view one of the most important items in their trade with this country will doubtless complicate to a serious degree the successful renewal of our commercial agreement with Russia.

It is of course true that when we assured the Russians that the Treasury would hold that Soviet coal would be exempt from the tax, we made the reservation that the Treasury’s decision would be “subject, however, to possible adverse action by the courts.” This reservation envisaged precisely the development which has now taken place, and our legal position is thus unassailable. It probably is difficult, however, for the Russians, in whose country all the organs of government—including the judicial authorities—bow to the will of the party leaders, to believe that our courts are really independent of the executive branch of the government and that their decisions do not reflect the policy of the administration. They will probably be inclined to suspect that we tricked them into the current agreement by promising favorable administrative action with respect to their coal and then slyly encouraging the courts to invalidate this action. It is this possible psychological effect of the recent action by the Treasury and not any legal complication which gives grounds for concern.

Negotiations for the renewal of this agreement should begin in the near future. Our position will be somewhat difficult in view of [Page 604] the favorable development of Soviet-American trade during the last year. Not only have the Russians failed to export to this country anywhere near the amount of coal that they may properly export but their purchases in this country have far exceeded those which they were bound by the agreement to make. Whereas they agreed to purchase $40,000,000 worth of American products in the period roughly corresponding with that of the fiscal year 1937–8, the actual amount of the orders placed by the Soviet Government in this country during this period is expected to exceed $75,000,000. During 1937 the United States became the leading source of imports into the Soviet Union, outstripping Germany and England in this respect. Russian sales to this country in general have only been roughly half of purchases from it. It might be added that the Russian market appears to be of particular importance at this moment to the American machine tool manufacturers.

This highly favorable development of trade between the two countries makes it particularly desirable that the system of annual commercial agreements and the comparatively friendly atmosphere which prevails in American-Russian commercial relations should be preserved. While in reality the increase of Russian purchases in this country has probably not been a direct result of the operation of the agreement, the Russians are sensitive to what might be called the agreement’s symbolic value. They like to be able to say that they have a successful commercial agreement with this country. In this sense the conclusion of these three successive annual commercial agreements has probably helped considerably in an indirect way to improve trade between the two countries. But if nothing is done by this Government with respect to the threatened tax on coal the Russians are going to be irritated and will probably be unwilling to renew the commercial agreement in its present form when it expires on August 6.

This situation could apparently be remedied in one of two ways. The first would be congressional action repealing this discriminatory tax. The second would be the conclusion with the Soviet Union of an actual treaty, to be ratified by the Senate, rather than merely a commercial agreement concluded on the authority of the Executive. It must be pointed out, however, that even this last expedient would apparently not make it entirely certain that Russian coal would not be subject to the tax. The Customs Court might hold that the phrase “unless treaty provisions of the United States otherwise provide” applied only to existing treaty provisions and not to the provisions of such treaties as might be concluded subsequent to the passage of the Act.

  1. For these negotiations see pp. 322 ff.
  2. Approved June 6, 1932; 47 Stat. 169, 259.
  3. See footnote 56, p. 405.
  4. For text of the agreement with the Netherlands signed December 20, 1935, see Department of State Executive Agreement Series No. 100, or 50 Stat. 1504.
  5. Imports of coal for the entire year amounted to 198,384 tons.
  6. 47 Stat. 253.