3. Claims Raised by the United States

5.48 The United States claims that Indonesia's discriminatory application of the luxury tax (See Section III.C) is inconsistent with Article III:2, first sentence, of GATT 1994. The following are the United States' arguments in support of this claim.

5.49 Article III:2, first sentence, provides as follows:

5.50 Under Regulation No. 36/1996, motor vehicles produced or assembled in Indonesia with a local content in excess of 60 per cent, or national motor vehicles that satisfy the local content requirements of Decree No. 31/1996, are exempt from the luxury tax. However, imported CBU motor vehicles that are "like" their Indonesian-made counterparts are subject to the luxury tax, the precise amount of the tax depending on the type of motor vehicle.⁸² Thus, the luxury tax on imported motor vehicles is "in excess of" the tax on like domestic motor vehicles that are exempt from the tax under Regulation No. 36/1996. As the Appellate Body stated in Japan - Taxes on Alcoholic Beverages, for purposes of Article III:2, first sentence, "[e]ven the smallest amount of 'excess' is too much".⁸³ Here, the amounts are not small, but instead are the difference between 0 and 35 per cent.

B. Claims Under Article III:2, Second Sentence of GATT 1994

1. Claims Raised by Japan

5.51 Japan argues that "the National Car Programme" of February 1996 (See Section III.A) violates Article III:2, second sentence of GATT 1994. The following are Japan's arguments in support of this claim:

5.52 Even if the National Car Programme did not violate Article III:2, first sentence, the National Car Programme still violates Article III:2, second sentence, which prohibits a Member country from applying "internal taxes or other internal charges to imported or domestic products in a manner contrary to the principle set forth in paragraph 1."

5.53 A recent Appellate Body report has held that:

(a) National Cars and imported automobiles are "directly competitive or substitutable" products

5.54 Japan indicates that the same evidence presented in the context of its "like product" argument for its claim under Article III:2, first sentence (See Section V.A.1) supports its argument in the context of its claim under Article III:2, second sentence that National Cars are indistinguishable from imported automobiles.

(b) National Cars and imported automobiles are not "similarly taxed"

5.55 Since National Cars are exempted from the luxury tax while any imported sedans are subject to 35 per cent luxury tax, they are obviously not taxed "similarly".

5.56 Moreover, according to the Indonesia in its notification of subsidies, the luxury tax exemption constitutes a "subsidy". If National Cars and imported sedans are indeed similarly taxed within the margin of de minimis magnitude⁸⁵, it is inconceivable how the tax exemption could constitute a "subsidy". Accordingly, by Indonesia's own admission National Cars and imported sedans are not similarly taxed.

(c) The tax exemption is accorded "so as to afford protection"

5.57 Indonesia has accorded the title of its Programme: "Development of the National Automobile Industry"⁸⁶ to the Presidential Instruction, which initiated the Programme. In addition to the Indonesian stated purpose of "the development of domestic motor vehicles in order that the national mobile industry can [quickly come] into being and can produce using brands created by itself", this objective is expressed unambiguously in "Elucidation on Government Regulation No. 36/1996", a supplementary legislative document for the government regulation granting tax exemption to National Cars.⁸⁷ It states:

5.58 "Objective" factors surrounding the tax exemption testify to its "protective" character as well.⁸⁸ As we have already discussed, the share of imported passenger automobiles has been insignificant for a variety of reasons which are unrelated to competitiveness of foreign products. To grant an additional advantage to domestic production in this environment would do nothing more than add a layer of "insulation" to the Indonesian market.

2. Claims Raised by the United States

5.59 The United States claims that Indonesia's discriminatory application of the luxury tax is inconsistent with Article III:2, second sentence, of GATT 1994. The following are the United States' arguments in support of this claim:

5.60 As argued in Section V.A.(3) the exemption from the luxury tax under the National Car Programme violates Article III:2, first sentence, of GATT 1994. Should the Panel find otherwise, it is nevertheless the case that this exemption constitutes a violation of Article III:2, second sentence, which prohibits a Member from applying "internal taxes or other internal charges to imported or domestic products in a manner contrary to the principle set forth in paragraph 1".⁸⁹

5.61 In Japan Liquor II, the Appellate Body set forth the following test for establishing a violation of Article III:2, second sentence:⁹⁰

5.62 All of the elements required by Article III:2, second sentence, as interpreted by the Appellate Body, are present in this case. First, there is ample evidence that the Timor Kia Sephia is "directly competitive or substitutable" with imported passenger cars. Second, the difference between a tax rate of zero and a tax rate of 35 per cent clearly constitutes non-similar taxation.

5.63 Finally, the tax exemption is accorded "so as to afford protection". The Elucidation on Government Regulation No. 36/1996, the instrument that actually confers the tax exemption, states that the purpose of the exemption is to "support the domestic automotive industry in order to further promote its growth particularly in the face of global competition".⁹¹ Moreover, the very size of the tax differential makes it clear that the dissimilar taxation was applied "so as to afford protection".⁹²

C. Claims Under Article III:4 of GATT 1994

1. Claims Raised by Japan

5.64 Japan claims that the local content requirements for the National Cars and their parts and components under the February 1996 programme (See Section III.A) violate Article III:4 of GATT 1994. The following are Japan's arguments in support of these claims:

5.65 The manufacturer of the National Cars (i.e., so called "pioneers") receive the following two substantive competitive benefits:

These benefits are conditioned on the attainment of the following levels of local content:

• At the end of first year, the local content rate of more than 20 per cent;
• At the end of second year, the local content rate of more than 40 per cent;
• At the end of third year, the local content rate of more than 60 per cent.

(a) Article III:4 of GATT 1994 requires each WTO Member to guarantee equality of competitive opportunity between domestic goods and imported goods

5.66 GATT Article III:4 provides as follows:

5.67 In Canada - Import, Distribution and Sale of Certain Alcoholic Drinks by Provincial Marketing Agencies, the panel found:

5.68 The test for compliance with GATT Article III:4 is two-fold. First, are the imported and domestic goods in question "like products"? Second, have the imported products received treatment "less favourable" than the domestic like product? Therefore, interpretation of Article III:4 in the context of the present dispute boils down to the following two elements:

(b) Imported parts and components and domestic parts and components are "like" products

5.69 Relevant factors in determining whether or not imported automotive parts and components and domestic automotive parts and components are "like products" may be constructed on a case-by-case basis by examining relevant factors including:

5.70 Domestic automotive parts and components and automotive parts and components from Japan are regarded as a single product for use in the assembly of automobiles, and thus it is practically unnecessary to discuss the "like" products issue further in this present case. Automotive parts and components are identical in all respects (including the end-uses, properties, nature and quality) with domestic ones may be imported from abroad.

5.71 Imported automotive parts and components from Japan and other WTO Members are "like" domestic parts and components that may be used in the assembly of National Cars. The only distinction that the Indonesia has made relevant under the Programme is not whether imported or domestic parts and components differ in any physical respect, but where they originate. Thus, imported and domestic parts and components are "like products" under Article III:4.

(c) Imported parts and components are accorded less favourable treatment than domestic like products in two respects

5.72 Only parts and components that originate in Indonesia contribute to the satisfaction by a National Car producer of the local content requirement upon which Indonesia has conditioned the duty free treatment of the remaining imported parts and components used to assemble the National Car and the luxury tax exemption on National Cars.

(1) The import duty exemption on automotive parts and components used in the assembly of National Cars conditioned upon the attainment of certain levels of local content accords advantages to domestic automotive parts and components not available to imported like products

5.73 WTO/GATT panels have consistently found that requirements to purchase domestic products to obtain an advantage violate Article III:4. The EC-Bananas III case, a WTO panel quoted and reaffirmed the following description by the 1994 GATT panel on EC-Bananas II regarding the scope of Article III:4:

5.74 The Bananas III finding reinforces firmly established GATT precedent (e.g. the 1958 panel report on Italian Discrimination Against Imported Agriculture Machinery⁹⁶ and the 1984 report on Canada - Administration of the Foreign Investment Review Act ("FIRA")⁹⁷).

5.75 On the basis of their domestic origin, Indonesian automotive parts and components receive treatment substantially more favourable than do even identical automotive parts and components imported from Japan and other WTO Members. In particular, only parts and components that originate in Indonesia contribute to the satisfaction by a National Car producer of the local content requirement upon which Indonesia has conditioned the import duty (and further luxury tax) exemption. In other words, Indonesia's National Car Programme established local content targets that automakers must satisfy in order to obtain a sliding scale of duty preferences, thereby favouring the purchase of domestic over imported like products for purposes of automobile production. The plain language of Article III:4, as applied in the EC - Bananas III and other cases (including the FIRA and Italian Agriculture Machinery cases) leaves no doubt that such an arrangement violates Article III:4.

(2) The luxury tax exemption on sales of National Cars conditioned upon the attainment of certain levels of local content accords advantages to domestic automotive parts and components not available to imported like products

5.76 On the basis of their domestic origin, Indonesian automotive parts and components receive treatment substantially more favourable than do even identical automotive parts and components imported from Japan and other WTO Members.

5.77 The conditioning of the luxury tax exemption on a local content requirement affords protection to domestic automotive parts and components because it promotes the sale of National Cars over other domestically assembled sedans that contain a greater proportion of imported parts. Such less favourable luxury tax treatment of imported products relative to a domestic like product stands in clear violation of Article III:4 precisely in the same way as the import duty exemption discussed in the preceding section.

To Continue with Claims Raised by the European Communities .

⁸²To reiterate, the applicable luxury tax rates under Regulation No. 36/1996 are: (1) 35 per cent for passenger cars and jeeps; (2) 25 per cent for light commercial vehicles (other than jeeps) that use diesel as fuel; and (3) 20 per cent for light commercial vehicles (other than jeeps) that use gasoline as fuel.

⁸³WT/DS8/R, WT/DS10/R, WT/DS11/R, Report of the Appellate Body, adopted 1 November 1996, p. 24.

⁸⁴Report of the Appellate Body on Japan - Alcoholic Beverages II, p.24. This three part test was affirmed by the Appellate Body Report in Canada - Periodicals, p.23.

⁸⁵Report of the Appellate Body on Japan - Alcoholic Beverages II, pp.26-27. We discuss whether the characterization of a "subsidy" constitutes the valid defence in para. 3.501 - 3.521 below.

⁸⁶Presidential Instruction No.2/1996 (Japan Exhibit 8).

⁸⁷Government Regulation No.36/1996 (Japan Exhibit 25).

⁸⁸Report of the Appellate Body on Japan - Alcoholic Beverages II, pp.27-31; Report of the Appellate Body on Canada - Periodicals, pp31-32.

⁸⁹In its request for the establishment of a panel in this case, the United States did not limit its claim under Article III:2 to the first sentence of that provision. In its first submission to the Panel, however, the United States limits its arguments to Article III:2, first sentence, based on the belief that there can be no serious disagreement that the tax incentives under the National Car programme discriminate against imported passenger cars that are "like" domestic passenger cars. Based on its interpretation of Indonesia's arguments submitted as of the end of the first meeting of the Panel, the United States does not believe that Indonesia has contested the fact that, insofar as Article III:2 is concerned, the products in question are "like products". However, in anticipation that Indonesia may revise its arguments at this stage of the proceeding, the United States addresses its claim under Article III:2, second sentence.

⁹⁰Japan - Taxes on Alcoholic Beverages, WT/DS8/AB/R, Report of the Appellate Body adopted 1 November 1996, page 25 (italics in original). The Appellate Body subsequently affirmed this test in Canada - Certain Measures Concerning Periodicals, WT/DS31/AB/R, Report of the Appellate Body adopted 30 July 1997, page 23.

⁹¹US Exhibit 10.

⁹²Japan - Taxes on Alcoholic Beverages, WT/DS8/AB/R, Report of the Appellate Body adopted 1 November 1996, page 32.

⁹³Canada - Import, Distribution and Sale of Certain Alcoholic Drinks by Provincial Marketing Agencies, DS21/R, adopted on 18 February 1992 (BISD 39S/27) para.5.5.

⁹⁴Working Party Report on Border Tax Adjustment, para.18; Report of the Appellate Body on Japan - Alcoholic Beverages II, p.19; Report of the Appellate Body on Canada - Periodicals, pp.19-20.

⁹⁵EEC-Import Regime for Bananas, DS38/R, para. 146, 11 February 1994 (not adopted)("EC - Bananas II"), as quoted and adopted by the WTO panel in EC - Regime for the Importation, Sale and Distribution of Bananas ("EC - Bananas III"), WT/DS27/R/USA, paras. 7.179 and 7.180.

⁹⁶See the 1958 panel report on Italian Discrimination Against Imported Agriculture Machinery, which concluded that Italian government credits for the purchase of domestically-produced machinery "might adversely modify the conditions of competition between the domestic and imported products" in violation of Article III:4. (BISD 7S/60, para. 12, adopted on 23 October 1958).

⁹⁷See 1984 report on Canada - Administration of the Foreign Investment Review Act ("FIRA"), in which the panel found that "requirements to buy from Canadian suppliers are inconsistent with Article III:4." (BISD 30S/140, para. 5.10, adopted on 7 February 1984.) In particular, the FIRA panel noted that the coverage of "requirements" under Article III:4 included "undertakings," even if voluntary, to purchase domestic products if: "once they were accepted [such undertakings] became part of the conditions under which the investment proposals were approved, in which case compliance could be legally enforced." (para. 5.4)