5.219 If adopted, Indonesia's lex specialis argument would create loopholes in the GATT large enough to undermine the WTO's fundamental purpose of trade liberalization. In Indonesia's view of the WTO system, sanitary measures, technical standards, and entire categories of other measures would be largely exempted from the GATT and other general WTO disciplines. This result would occur, perversely, despite the facts that such measures were undeniably subject to the GATT before the Uruguay Round and that the clear purpose of the Uruguay Round was to strengthen - not weaken - multilateral disciplines.

5.220 The damage to the WTO system that would result from adoption of Indonesia's lex specialis argument is well illustrated by this case, since it would excuse Indonesia's violations of GATT Articles I:1, X:1, and X:3, although nothing about the SCM Agreement comes anywhere close to waiving the MFN obligation, excusing Indonesia's failure to publish its programmes, or allowing it to administer its programmes unreasonably and partially.

(b) The SCM Agreement would not be reduced to inutility by Article III:2 of GATT

5.221 As noted by the Appellate Body and previous Panels, under general rules of treaty interpretation, one must give meaning and effect to all terms of a treaty and must not "adopt a reading that would result in reducing whole clauses or paragraphs of a treaty to redundancy or inutility."¹⁹⁴ Indonesia invokes this principle in an attempt to prove that GATT Article III:2 does not apply to the National Car Programme, contending that application of Article III:2 would reduce the entire SCM Agreement to inutility. (See Section V.D.2). That argument is not only wrong, but backwards, and it should be rejected.

5.222 In fact, the SCM Agreement will continue to impose a variety of substantive and procedural disciplines on subsidies and countervailing measures regardless of the applicability of GATT Article III:2. There exist various subsidies which are subject to the SCM Agreement and are not proscribed by GATT Article III:2. For example, exempting domestic enterprises from certain internal taxes or charges, such as registration taxes, would not violate GATT Article III:2, when those taxes or charges are not applied in connection with imported products. However, such measures still fall into the scope of Article 1(a)(1)(ii) and Article 2.1 of the SCM Agreement and therefore these measures are subject to the disciplines of the SCM Agreement to their fullest extent.

5.223 Further, the SCM Agreement is not meaningless, even though GATT Article III, as a whole, applies to subsidies. The text of GATT Article III supports this observation, because the "subsidies" covered by GATT Article III:8(b) are not prevented by GATT Article III, but they may still be subject to the provisions of the SCM Agreement. Thus, it is plainly wrong to say that the SCM Agreement would be reduced to inutility if the Panel rules that GATT Article III:2, or the entire GATT Article III, applies to this case.

5.224 By contrast, GATT Article III:2 would be reduced to inutility if one accepted Indonesia's view of the SCM Agreement. Under that view, SCM Article 27.3 grants developing country Members a licence to impose discriminatory taxes on imported goods in clear contravention of GATT Article III:2. That view would further lead to an absurd conclusion that even developed country Members could engage in such discriminatory taxation, provided only that such discrimination was not contingent on the use of domestic over imported products, since nothing in the SCM Agreement prohibits such kinds of subsidies. It should be apparent that Indonesia's approach would eviscerate GATT Article III:2. All discriminatory internal taxation that had previously been regarded as violations of GATT Article III:2 would be suddenly recast as "subsidies" exempt from GATT Article III:2 disciplines. There would be no GATT Article III:2, because its sole function is to prohibit discriminatory internal taxes and they would all be exempt from its disciplines. The reasoning of the US - Malt Beverages Panel is exactly on point; that Panel rejected an argument like Indonesia's, declaring that "such an interpretation would virtually eliminate the prohibition in Article III:2 of discriminatory internal taxation by enabling contracting parties to exempt all domestic products from indirect taxes."¹⁹⁵

5.225 Thus, the Appellate Body's warning that WTO provisions cannot be construed in a manner that deprives them of all force and effect precludes giving the SCM Agreement such a broad construction as to essentially repeal GATT Article III:2.¹⁹⁶ There is no danger of GATT Article III:2 reducing the SCM Agreement to inutility, but, as US - Malt Beverages recognized, adoption of Indonesia's argument would most certainly have that effect on GATT Article III:2.¹⁹⁷

5.226 Other considerations also strongly dictate that the SCM Agreement must be construed to avoid this result. First, WTO cases that have addressed potential areas of conflict or overlap between WTO Agreements have favoured application of each agreement in accordance with its terms, rather than allowing one agreement to override another unnecessarily.¹⁹⁸ Second, numerous Panels over the years have recognized GATT Article III:2's critical importance both in its own right and in maintaining the effectiveness of Articles I (MFN) and II (tariff bindings).¹⁹⁹ Finally, there is no doubt that before the Uruguay Round Article III:2 prohibited discriminatory internal taxes and it would be perverse to construe a Uruguay Round Agreement in a manner that undermined an essential GATT discipline.

(c) GATT Article III does not "conflict" with the SCM Agreement

5.227 Indonesia also argues that the SCM Agreement conflicts with GATT Article III:2 and, per the General Interpretative Note, the SCM Agreement prevails in the conflict. That argument cannot be supported because there is no such conflict.

5.228 The Bananas III Panel construed the term "conflict" in the General Interpretative Note to include both cases of "mutually exclusive" obligations and cases where the GATT prohibits what an Annex 1A Agreement "explicitly permits," but not to cases where the two agreements provide for "different or complementary obligations." As the United States has observed, the Bananas III Panel construed the term "conflict" rather broadly. (See Section V.E.3). A finding that a "conflict" arises only where two agreements establish "mutually exclusive" obligations would be more in keeping with the drafting history of the General Interpretative Note (See Section V.E.1) and with earlier decisions that have sought to minimize potential conflicts between WTO agreements.²⁰⁰ Even if one accepts the broad view of "conflict" from Bananas III, however, there is no "conflict" between the SCM Agreement and GATT Article III:2.

(1) The obligations of GATT Article III:2 and the SCM Agreement are not "mutually exclusive"

5.229 It is so clear that a Member may comply with the obligations of both GATT Article III and the SCM Agreement simply by not engaging in tax discrimination that Indonesia does not even seriously argue that the two are "mutually exclusive." Indonesia's does state that its "obligations under the two provisions would be mutually exclusive," but that cannot be regarded as a serious argument, because Indonesia did not (and could not) identify a single obligation of the SCM Agreement that requires conduct in violation of GATT Article III:2. Instead, it appears that Indonesia has confused the two prongs of Bananas III.

(2) The SCM Agreement does not "explicitly permit" tax discrimination in violation of GATT Article III:2

5.230 Indonesia's entire "conflict" argument depends on a finding that the SCM Agreement "explicitly permits" violations of Article III:2. But Indonesia fails to point the Panel to any such "explicit" language in the text. It would be impossible to do so. There simply is no language in the SCM Agreement that "explicitly permits" tax discrimination in violation of GATT Article III. The Textiles and Clothing Agreement explicitly authorized an exemption from the obligation to eliminate quantitative restrictions provided by GATT Article XI. Lacking any language in the SCM Agreement, equivalent to that under Articles I and II of the ATC, one cannot jump to the conclusion that the relationship between Article III and the SCM Agreement is "analogous to the relationship between Article XI and the ATC."

5.231 Lacking textual support, Indonesia nevertheless soldiers on by advancing a lengthy, elaborate, and rather convoluted argument about "actionable subsidies."

5.232 But still, nothing about Indonesia's argument shows that the SCM Agreement authorizes - explicitly or implicitly - "actionable subsidies" that violate GATT Article III:2. Indonesia concludes that "the SCM [Agreement] specifically does not prohibit developing countries from granting a subsidy involving differential internal tax treatment on products and ..., on the other hand, Article III:2 of GATT 1994 prohibits such differential internal tax treatment on products", and that this situation is "conflict". (See Section V.D.). Indonesia appears to be attempting, sub silentio, to stretch the definition of "explicitly permits". Indonesia would have the Panel believe that something the SCM Agreement "does not prohibit" is "explicitly permitted". Silence on tax discrimination can never mean "explicit permission", however. Therefore, the Panel should reject Indonesia's attempt to equate silence with "explicit permission".

5.233 The Indonesian argument seems to stem from a misunderstanding of Article 27.3 of the SCM Agreement. By its terms, SCM Article 27.3 provides developing country Members a temporary exemption from one obligation of the SCM Agreement, specifically, from SCM Article 3.1(b)'s prohibition of subsidies conditioned upon the use of domestic over imported goods. For developing country Members, during the five year transitional period, subsidies conditioned upon the use of domestic over imported goods are not deemed to be prohibited subsidies under Part II of the SCM Agreement, but are still actionable subsidies under Part III by virtue of Article 27.3. However, are actionable subsidies "explicitly permitted" to ignore GATT Article III? The answer is obviously negative. As demonstrated so far, GATT Article III does and should apply to subsidies under the SCM Agreement, including actionable subsidies. There is no reason to read an exemption from SCM Article 3.1(b) as an exemption from GATT Article III, or from any other WTO obligation. To the contrary, exceptions from GATT principles have traditionally been interpreted narrowly by GATT and WTO panels, and as already discussed, footnote 56 to the SCM Agreement provides that the SCM Agreement does not "preclude action under other relevant provisions of GATT 1994, where appropriate."

(3) The SCM Agreement and GATT Article III:2 create "different or complementary" obligations

5.234 The Panel should recognize that the SCM Agreement and GATT Article III:2 create "different or complementary obligations". As described by the Bananas III Panel, two provisions are "different or complementary", and do not conflict, if "both can be complied with at the same time without the need to renounce explicit rights or authorizations". GATT Article III:2 and the SCM Agreement can both be complied with and Indonesia has failed to show that such compliance would require it to renounce any "explicit rights".

5.235 It should be recalled here that what triggers the luxury tax exemption is not merely the use of a domestic product (i.e., parts and components) by a domestic producer, it is the sale of a domestic product (i.e., an automobile) with domestic content to the final consumer. We therefore do not have here only the type of discrimination addressed by Article 3.1(b) of the SCM Agreement (i.e., a subsidy to a producer contingent upon use of a domestic product), but also a type of discrimination governed only by GATT Article III:2 (i.e., internal tax discrimination between imported and domestic products). This highlights the fact that GATT Article III and SCM Article 3.1(b) have clearly different purposes, coverage, and remedies.

5.236 Further, with regard to remedies, the SCM Agreement allows both dispute settlement procedures under Article 4 or Article 7 and countervailing measures in accordance with Part V of the Agreement, while remedies for violations of GATT Article III:2 are provided under GATT Article XXII and Article XXIII. In this respect, Indonesia attaches too much emphasis to the higher burden of proof under the SCM Agreement. However, Indonesia's proposition that the SCM Agreement is more favourable to defending parties than GATT Article III in terms of remedial procedures, and thus provides defending parties some procedural rights, is questionable. The remedial process under Article 7 of the SCM Agreement is much more expeditious than those under the Dispute Settlement Understanding. Complaining parties are required to prove adverse trade effects but they can secure remedies under Article 7 of the SCM Agreement much earlier than in the case of a claim concerning the infringement of the GATT obligations under the DSU. In other words, complaining parties bear the burden of proving adverse trade effects in exchange for a more expeditious remedy. Indonesia also stresses that, under Article 7 of the SCM Agreement, the only remedy required is to eliminate "the adverse effects". However, we do not see any substantial difference between the obligations to eliminate the adverse effects and those to bring the measures into conformity with the GATT obligations. It should also be noted that under Article 7 of the SCM Agreement "appropriate steps to remove the adverse effects" have to be taken within 6 months from the date of adoption of the recommendations by the DSB, only 2/5 of the 15 months guideline for the "reasonable period of time" to implement the DSB recommendations stipulated by Article 21.3 of the DSU. Therefore, even though Article III of the GATT 1994 is applicable, complaining parties may choose to resort to Article 7 of the SCM Agreement, as the United States and the European Communities do in this case.

(4) "Conflict" should be narrowly interpreted

5.237 In keeping with the fundamental objective and purpose of the WTO system - trade liberalization - WTO cases that have addressed potential areas of conflict and overlap between the WTO agreements have favoured application of each agreement in accordance with its terms to the maximum extent possible, rather than unnecessarily allowing one agreement to override another.²⁰¹

5.238 Given that under the WTO system, waivers and exceptions "have to be interpreted narrowly"²⁰², the waiver of the prohibition under Article 3.1(b) of the SCM Agreement cannot reasonably be interpreted as a license to violate any and all other obligations under the WTO agreements. Japan's claim under Article III of GATT 1994 is not that the Programmee provides a prohibited subsidy, but that it violates national treatment, including Indonesia's obligation under GATT Article III:2 to tax domestic and imported like products at the same rate. If the WTO Members had intended to waive the obligations under GATT Article III:2 entirely for developing countries, they would have done so explicitly, given that "[t]he MFN requirement in Article I, and also tariff bindings under Article II, would become ineffective" without enforcement of the Article III:2 prohibition on discriminatory tax measures, including discriminatory tax exemptions.²⁰³

5.239 The drafting history of the term "conflict" in the General Interpretative Note in the "third track" negotiating group also confirms that the term suggests an irreconcilable difference. The initial discussion on the relationship between GATT 1994 and the other WTO agreements occurred during the drafting of the Understanding on Rules and Procedures Governing the Settlement of Disputes ("DSU") in the "third track" negotiating group chaired by Mr. Julio Lacarte. The delegation of Canada then submitted on 14 October 1993 a proposal entitled "Conflict of Substantive Provisions" that included the addition of the following "Headnote to Annex 1A in the MTO Agreement":

5.240 At the session of 19 October 1993, the delegation of Japan proposed to delete the term "inconsistency" and replace it with the term "conflict". Other delegations approved this amendment, and it was incorporated in a working paper dated 6 December 1993 prepared by the secretariat to record the results of this session and to facilitate future discussions among the negotiating group.²⁰⁵ The delegations that addressed this amendment at the session generally concurred that it was intended to clarify the limited number of instances in which the Note would apply. Whereas "inconsistency" was open to a broad interpretation, "conflict" referred only to irreconcilable differences between an obligation under GATT 1994 and an obligation under another WTO agreement, such that the provisions of the two agreements were mutually exclusive and could not both be enforced at the same time.

(d) GATT Article III:8(b) has never excused tax discrimination and should not be "re-thought" to excuse it now

(1) GATT Article III:8(b) has never excused tax discrimination

5.241 Article III:8(b) provides that Article III "shall not prevent the payment of subsidies exclusively to domestic producers, including payments to domestic producers derived from the proceeds of internal taxes or charges applied consistently with the provisions of this Article ...."

5.242 As is evident from the textual reference to "payments . . . derived from the proceeds of internal taxes," the scope of Article III:8(b) is limited to direct payments to producers. Other measures that may be characterized as "subsidies," such as discriminatory tax breaks for domestic products, are not covered.

5.243 This plain understanding of Article III:8(b) was confirmed by the GATT Panel in US - Malt Beverages.²⁰⁶ That Panel unequivocally rejected the argument that discriminatory tax breaks were "subsidies" protected by Article III:8(b), declaring that such an argument was contrary to the text, "context, declared purpose and drafting history of Article III."²⁰⁷ The drafting history could hardly be more clear about this point; the Havana Conference rejected an alternative to Article III:8(b) proposed by the Cuban delegate that would have expressly permitted "the exemption of domestic products from internal taxes as a means of indirect subsidization. . . ."²⁰⁸ This evidence from the drafting history confirms the plain text of Article III:8(b) in showing that it is limited to direct payments to producers. Discriminatory tax breaks for products have never been covered by Article III:8(b), and are inconsistent with GATT Article III:8(b). The US - Malt Beverages decision was followed by the GATT Panel in US - Tobacco and it was reaffirmed in Canada - Periodicals, by the Appellate Body which declared that Article III:8(b) "was intended to exempt from the obligations of Article III only the payment of subsidies which involve the expenditure of revenue by a government."²⁰⁹

5.244 Therefore, it is beyond doubt that the well-settled understanding of Article III:8(b) is that it covers direct payments of subsidies, but not discriminatory tax breaks. Indonesia does not dispute this. Instead, it admits that its position is inconsistent with the prevailing understanding of Article III:8(b) by advocating a "re-thinking" of that Article. (See Section V.D.)

5.245 Also, even if the discriminatory tax breaks could be considered as "subsidies" under GATT Article III:8(b), they are not directed "exclusively to domestic producers". The direct beneficiaries of the luxury tax exemption are consumers, not the producer of National Cars or producers of its parts and components.²¹⁰

(2) GATT Article III:8(b) should not be "re-thought" to excuse tax discrimination

5.246 Indonesia argues that GATT Article III:8(b) should be "re- thought" to exempt "all subsidies identified in Article 1 of the SCM Agreement" from the obligations of GATT Article III. (See Section V.D). In other words, Indonesia argues that the SCM Agreement's definition of "subsidy" should be read into Article III:8(b). Because the SCM Agreement's definition of "subsidy" includes foregoing "government revenue that is otherwise due", Indonesia argues that this Panel should reject US- Malt Beverages.

5.247 It is Indonesia's argument that should be rejected. The SCM Agreement itself rejects the notion that its definition of "subsidy" should be applied to other WTO Agreements. SCM Article 1.1 expressly states that the definition of "subsidy" is provided "[f]or the purpose of this Agreement." There is no suggestion anywhere in the WTO text that the SCM definition of "subsidy" should be applied to GATT Article III.

5.248 Indonesia's argument is also undermined by the fact that the Appellate Body reaffirmed US - Malt Beverages in Canada - Periodicals.²¹¹ If the Appellate Body considered that the scope of Article III:8(b) had to be "re-thought" in light of the SCM Agreement, it could have and should have done so in Canada - Periodicals. But it did not "re-think" Article III:8(b); it reaffirmed the accepted understanding. Faced with this glaring flaw in its argument, Indonesia argues weakly that Canada did not argue for application of the SCM Agreement in that case. But what Canada did or did not argue in a previous case is wholly irrelevant here. What matters is that the Appellate Body has considered the scope of Article III:8(b) and has decided that it applies only to direct subsidy payments, not to discriminatory tax breaks. Indonesia's position is at odds with the Appellate Body's interpretation of Article III:8(b), and it should be rejected.

5.249 Moreover, the rationale of US - Malt Beverages remains every bit as valid today as it was when adopted. It is still the case that including tax discrimination within the scope of Article III:8(b) is contrary to the text, context, declared purpose, and drafting history of Article III. It also remains true that "the prohibition of discriminatory internal taxes in Article III:2 would be ineffective if discriminatory internal taxes on imported products could be generally justified as subsidies for competing domestic producers in terms of Article III:8(b)."²¹² Thus, the Appellate Body's admonition against reducing WTO provisions to inutility precludes any "re-thinking" of Article III:8(b) that would render Article III:2 ineffective. And, once again, there is no reason whatsoever to believe that, by strengthening multilateral disciplines on subsidies, the Uruguay Round essentially repealed Article III:2's prohibition on discriminatory taxation. As stressed in the beginning of this Part, weakening Article III by abandoning its established interpretation and adopting Indonesia's proposed "re-thinking" would cause grave harm to the core WTO disciplines of MFN, tariff bindings, and national treatment.²¹³

5.250 For all these reasons, the Government of Japan submits that there is no reason for the Panel to abandon a well-established and recently reaffirmed interpretation of a key GATT provision.

To Continue with Rebuttal arguments of the European Communities .

¹⁹⁴Appellate Body Report on US - Gasoline, p. 23; Appellate Body Report on Japan - Taxes on Alcoholic Beverages ("Japan - Alcoholic Beverages II"), WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R, adopted on 1 November 1996, p. 12.

¹⁹⁵See Panel Report on United States - Measures Affecting Alcoholic and Malt Beverages ("US - Malt Beverages"), DS23/R, adopted on 19 June 1992 (BISD 39S/206), para. 5.12.

¹⁹⁶See, e.g., Appellate Body Report on Japan - Alcoholic Beverages II, p.12.

¹⁹⁷Panel Report on US - Malt Beverages, para. 5.12.

¹⁹⁸Panel Report on Canada - Certain Measures Concerning Periodicals ("Canada - Periodicals"), WT/DS31/R, adopted on 30 July 1997, as modified by the Appellate Body, paras. 5.17-5.18. Appellate Body Report on Canada - Periodicals, WT/DS31/AB/R, adopted on 30 July 1997, p. 18.

¹⁹⁹See, e.g., Panel Report on US - Malt Beverages, paras. 5.9, 5.12.

²⁰⁰See, e.g., Report of the Appellate Body on Canada Periodicals, p. 18. The WTO Secretariat presented its views on the concept of "conflict" between two international agreements in connection with the negotiation of the Multilateral Agreement on Investment. The WTO Secretariat stated that, in the strict sense of the term, a conflict of law arises where an act obligated under one agreement is prohibited under another. The WTO Secretariat also differentiated the concept of "conflict" from the concept of "overlap." "Relationship of Proposed MAI Provisions to the WTO - Note by the WTO Secretariat," DAFFE/MAI/RD(96)37 (Japan Exhibit 68, p.2). See also "The Relationship between the MAI and the WTO Agreements (Note by the Chairman)," DAFFE/MAI/(96)21 (Japan Exhibit 69).

²⁰¹See, e.g., Report of the Appellate Body on Canada - Periodicals, page 19.

²⁰²As noted in the GATT panel report on US - Countervailing Duties on Fresh, Chilled and Frozen Pork from Canada, provisions that constitute "an exception to basic principles of the General Agreement had to be interpreted narrowly." BISD 38S/30, para. 4.4, adopted 11 July 1991. See also Norway - Procurement of Toll Collection Equipment, GPR DS2/R, para. 4.5, adopted 13 May 1992 ("Since Article V:16(3) [of the Government Procurement Agreement] was an exceptions provision, its scope had to be interpreted narrowly"); Canada - Import Restrictions on Ice Cream and Yoghurt, BISD 36S/68, para. 59, adopted 4 December 1989 (The panel "noted, as had previous panels, that exceptions were to be narrowly interpreted.").

²⁰³US - Malt Beverages, paras. 5.9, 5.12.

²⁰⁴Canadian Proposal "Conflict of Substantive Provisions" dated 14 October 1993 (Japan Exhibit 64).

²⁰⁵Draft prepared by the GATT Secretariat dated 6 December 1993 (Japan Exhibit 65).

²⁰⁶Panel Report on US - Malt Beverages, paras. 5.7-5.12.

²⁰⁷Id. at para. 5.9.

²⁰⁸Id. at para. 5.11.

²⁰⁹Panel Report on United States - Measures Affecting the Importation, Internal Sale and Use of Tobacco, DS44/R, adopted on 4 October 1994, para. 109 & note; Report of the Appellate Body on Canada - Periodicals, pp. 31-33 (emphasis added).

²¹⁰See Panel Report on Italian Agricultural Machinery, para.14 (holding that Article III:8(b) does not apply to payments granted to purchasers of agricultural machinery, because such payments cannot be regarded as subsidies to the producers of the machinery). See also European Economic Community - Payments and Subsidies paid to Processors and Producers of Oilseeds and related Animal-Feed Proteins ("EEC - Oilseeds"), L/6627, adopted on 25 January 1990, 37S/86, para.137 (holding that subsidy payments that economically benefit oilseed processors, and not only oilseed producers, are not subsidies paid "exclusively to domestic producers" under Article III:8(b)).

²¹¹Appellate Body Report on Canada - Periodicals, pp. 32-34.

²¹²Panel Report on US - Malt Beverages, para. 5.9.

²¹³Id. paras. 5.9, 5.12.