5.251 The following are the European Communities' arguments rebutting Indonesia's general response to the claims raised under Article III of GATT 1994:

(a) GATT Article III and the SCM Agreement are not mutually exclusive

5.252 Indonesia does not even attempt to argue that the tax incentives identified in Section III.B are consistent with GATT Articles III:2, first sentence, and III:4. Instead, Indonesia contends that those measures are "subsidies" within the meaning of the SCM agreement and, as such, not subject to GATT Article III but only and exclusively to the SCM Agreement.

5.253 The European Communities does not dispute that the measures at issue are subsidies. Indeed, the European Communities claims that those measures are "specific subsidies" within the meaning of the SCM Agreement which cause "serious prejudice" to its interests, contrary to Indonesia's obligations under that Agreement. Nevertheless, the European Communities is of the view that GATT Article III and the SCM Agreement are not mutually exclusive and, therefore, can be applied simultaneously to the same measures.

(1) GATT Article III:8(b) confirms that Article III applies to subsidies

5.254 Article III:8(b) of GATT reads as follows:

5.255 Article III:8(b) does not create an exception to the other provisions of Article III. Rather, the purpose of Article III:8(b) is to clarify that the other provisions of Article III do not apply to certain types of subsidies.²¹⁴ Those subsidies which are not covered by Article III:8(b) are not contrary per se to the other provisions of Article III. Nonetheless, Article III:8(b) has the clear implication that measures not falling within that provision are not exempt from the other provisions of Article III simply because they can be characterized as "subsidies".

5.256 The use of the term "payment" in the phrase "payment of subsidies" clearly indicates that the scope of Article III:8(b) is limited to subsidies involving an actual transfer of funds from the Government to domestic producers. Exemptions or reductions from an indirect sales tax on products do not involve any such transfer of funds. Therefore, that type of subsidies is not covered by Article III:8(b). The same reasoning applies in the case of subsidies in the form of an exemption or reduction of import duties.

5.257 The drafting history of GATT provides further confirmation that Article III:8(b) was not intended to cover exemptions or reductions from indirect taxes on products. The Report of the Sub-Committee at the Havana Conference which examined this provisions noted that:

5.258 Furthermore, the drafters of Article III explicitly rejected a proposal by Cuba at the Havana Conference to amend that Article to read:

5.259 This view is also supported by the 1992 Panel Report on US - Measures Affecting Alcoholic and Malt Beverages. In that case, the United States argued that the application of a lower excise tax to small United States producers of beer was allowable as a subsidy under Article III:8(b). This defence was categorically rejected by the Panel:

5.260 Indonesia contends that the Panel Report on US - Measures affecting Alcoholic and Malt Beverages was adopted under the GATT 1947 and that it is necessary to "re-think" the scope of Article III:8 (b) in light of the WTO Agreement, and in particular of the SCM Agreement. More precisely, according to Indonesia, "under the WTO, the 'payment of subsidies' language in Article III:8 (b) must refer to all subsidies identified in Article 1 of the Subsidies Agreement". (See Section V.D.)

5.261 Yet, in the recent case Canada - Certain measures concerning Periodicals²¹⁸, the Appellate Body has endorsed expressly the Panel Report on US - Measures Affecting Alcoholic and Malt Beverages, thus confirming that the interpretation of Article III:8 (b) of GATT made by that Panel remains still valid under GATT 1994.

5.262 The issue in dispute in Canada - Certain measures concerning Periodicals was whether the application by Canada Post of a reduced postal rate to certain domestic periodicals was a subsidy covered by Article III:8 (b). Following a careful examination of the text, the context and the drafting history of that provision in line with the analysis made in the preceding paragraphs, the Appellate Body concluded as follows:

5.263 The Appellate Body then went on to express its agreement with the following passage of the Panel Report on US - Measures affecting Alcoholic and Malt Beverages:

5.264 Thus, contrary to the suggestions advanced by Indonesia, in Canada - Certain measures concerning Periodicals the Appellate Body made it very clear that a subsidy in the form of an exemption or reduction of tax rates on a product does not fall within Article III:8(b). The Appellate Body Report on Canada - Certain measures concerning Periodicals cannot be explained away simply by saying that Canada did not raise the argument that the measures at issue were subsidies covered by the SCM Agreement. (See Section V.D). GATT Article III:8(b) cannot have different meanings depending on the arguments raised by the parties to a dispute. If the SCM Agreement had changed the meaning of GATT Article III:8(b), the Appellate Body should have taken into account that new meaning, even if it was not invoked by Canada.

(2) The SCM Agreement is not lex specialis

5.265 As a preliminary remark, the European Communities notes that it may be questionable whether the lex specialis principle qualifies as a "customary rule of interpretation of public international law" in the sense of Article 3.2 of the DSU. The defendant has not provided any evidence to that effect. Furthermore, the European Communities notes that such principle is nowhere mentioned in the Vienna Convention on the Law of the Treaties.

5.266 Assuming that the lex specialis rule was in fact a customary rule of public international law, the General Interpretative Note to Annex 1A would exclude its application between the GATT and the other Annex 1A Agreements. The clear intention of the WTO drafters was that the relationship between the GATT 1994 and the other Agreements included in Annex 1A should be governed only and exclusively by the rule contained in the General Interpretative Note to Annex 1A. The wording of that Note was carefully chosen so as to restrict the number of instances where the other Agreements included in Annex 1A would prevail over GATT 1994. (See Section V.E.1.) Those cautions would have been unnecessary if the drafters had envisaged the application of the lex specialis rule between GATT and the other Annex 1 Agreements.²²¹

5.267 In any event, Indonesia has not shown that the SCM Agreement is the lex specialis in this dispute. Unlike GATT Article III:2, which is specifically concerned with indirect taxation, the SCM Agreement does not contain any rule dealing specifically with indirect taxes. Moreover, whilst virtually all measures falling within Article III:2 may be construed as "subsidies" within the meaning of Article 1 of the SCM Agreement, the opposite is clearly not true: most subsidies subject to the SCM Agreement do not fall within either Article III:2 or any of the other provisions of Article III. Thus, if the lex specialis principle was deemed applicable, Article III:2 and not the SCM Agreement would have to be considered as the relevant lex specialis with respect to the tax exemptions and reductions granted by Indonesia. As will be shown below GATT Article III:4 and the SCM Agreement overlap. Some (but by no means all) measures covered by Article III:4 are also covered by the SCM Agreement. Thus, it cannot be said that any one of them is lex specialis with respect to the other.²²²

(3) The application of GATT Article III to subsidies does not render the SCM Agreement redundant

5.268 Indonesia's contention that virtually all subsidies other than subsidized import duties are contrary to GATT Article III is based on a gross misinterpretation of the scope of that provision. Moreover, it ignores that the remedies provided by the SCM Agreement are different from the remedies available in case of breach of the GATT.

5.269 Article 1 of the SCM Agreement identifies three different ways in which a Government can provide a subsidy²²³:

5.270 Direct transfers of funds are not covered by GATT Article III:2, which is concerned only with the application of indirect taxes on products. Moreover, loans, grants or equity infusions are not "laws, regulations or requirements" which "affect" as such the internal sale, offering for sale, purchase, transportation, distribution or use of products.²²⁴ For that reason, the granting of this category of subsidies cannot breach by itself GATT Article III:4. As shown by previous Panel Reports, this type of subsidies may be contrary to Article III:4 only to the extent that they are linked to a measure which affects the internal sale, purchase, use, etc. of domestic goods. For example, in Italian Agricultural Machinery²²⁵, the Panel found that an Italian law providing special credit terms to farmers for the purchase of agricultural machinery conditional upon the purchase of machinery produced in Italy was, by virtue of that condition, contrary to GATT Article III:4. As discussed above, that subsidies in the form of direct transfer of funds are not caught by GATT Article III is further confirmed by GATT Article III:8(b).

5.271 The above considerations are equally applicable in the case of subsidies falling within category (iii), even if GATT Article III:8(b) does not refer to the provision of goods and services to a domestic producer. Thus, for instance, the provision of raw materials by the Government at a subsidized price would not be contrary to either Article III:2 or Article III:4, because it does not affect as such the internal sale, offering for sale, etc of goods. On the other hand, the provision by the Government of, for example, services of transportation or distribution at subsidized rates only for domestic goods would be contrary to Articles III:4²²⁶ and/or III:2.

5.272 Category (ii) includes, in essence, three different types of subsidies: subsidies granted in respect of indirect taxes on products; subsidies granted in respect of import duties; and subsidies granted in respect of direct taxes.

5.273 If the taxes are indirect, GATT Article III:2 may apply. In contrast, subsidies granted in respect of direct taxes are not covered by Article III:2 which, to repeat, is concerned only with indirect taxes. Nor are those subsidies subject to GATT Article III:4. First, because direct taxes are not applied on "products" and therefore do not "affect" as such their sale, offering for sale, etc. Moreover, a reduction or exemption from a direct tax could never be considered to give "more favourable treatment" in the sense of Article III:4, given that foreign producers (and indirectly their products) are not subject to those taxes in the first place. Like the subsidies falling within the category (i), subsidies granted in respect of direct taxes may infringe Article III:4 only to the extent that they are linked to other conditions which favour the use, purchase, etc. of domestic products.

5.274 Subsidies granted in respect of import duties are not covered, in principle, by Article III since import duties are border measures. Nevertheless, this type of subsidies may violate Article III:4 where, as in the present dispute, its granting is conditional upon compliance with a measure, such as a local content target, which affects the internal use of products (see Section V.F.3).

5.275 In sum, whilst GATT Article III and the SCM Agreement may overlap in respect of certain measures, most subsidies covered by the SCM Agreement do not fall within the scope of GATT Article III.

5.276 Moreover, Articles 4 and 7 of the SCM Agreement provide specific remedies which are more rigorous for the subsidising Member than the ordinary remedies available under the DSU in case of breach of GATT Article III.

5.277 The importance of this difference is perfectly illustrated by the present dispute. If the Panel finds that Indonesia has violated Article III of GATT, Indonesia will be required "to bring the measure into conformity with" the GATT (cf. Article 19 of the DSU). In practice, this means that Indonesia will have to amend or repeal the measures, but only for the future.

5.278 In contrast, if the Panel found that those measures constitute subsidies which have caused "serious prejudice" to the interests of the EC, Indonesia would be required, in accordance with Article 7.8 of the SCM Agreement, to "withdraw" the subsidies or to "remove" its "adverse effects". This may imply the obligation for Indonesia not just to repeal or amend the measures but in addition to recover the unpaid duties and taxes on motor vehicles which have already benefited from those exemptions, to the extent that those subsidies continue to cause "adverse effects".

(4) The non-application of GATT Article III:2 to subsidies would render GATT Articles III:2 and III:8(b) superfluous

5.279 Whilst, for the reasons explained above, the application of GATT Article III to subsidies would by no means render the SCM Agreement redundant, its non-application would reduce GATT Article III:2 to inutility. In effect, any measure falling within GATT Article III:2 can be construed as "revenue foregone" within the meaning of Article 1.1 (a) (1) (ii) of the SCM Agreement and therefore as a "subsidy".

5.280 As noted by the Panel Report on US - Measures affecting Alcoholic and Malt Beverages:

5.281 Furthermore, Indonesia's lex specialis argument also would reduce to inutility GATT Article III:8(b). In fact, if the SCM was lex specialis with respect to Article III:2 whenever a subsidy is involved, there would be no need to clarify in the GATT that certain categories of subsidies are not covered by GATT Article III.

(5) The SCM Agreement has not modified the relationship between the rules on subsidies and the rules on national treatment which existed under GATT 1947

5.282 Under GATT 1947, there was no question that Article XVI was lex specialis vis-à-vis Article III to the extent that "subsidies" were concerned; or that there was a "conflict" between those two provisions simply because Article XVI did not prohibit certain types of measures that were prohibited by Article III.

5.283 Indonesia does not, apparently, dispute that under GATT 1947 Article III and Article XVI were not mutually exclusive. Yet, Indonesia contends that "all of that changed with the entry into force of the WTO". Indonesia gives two reasons for that "change". The first reason is that the SCM Agreement provides an "all encompassing structure of remedies" against subsidies. The second reason is that the SCM Agreement contains a definition of "subsidy". As will be shown below, both reasons are far from compelling.

5.284 Article XVI of GATT 1947 did contain also an "all encompassing structure of remedies applicable to subsidies", in the sense that it provided remedies with respect to all subsidies. Section A laid down a remedy for all "subsidies in general"; whereas Section B provided additional remedies for export subsidies. The remedies provided in Section A of Article XVI in respect of the type of subsidies at issue in this dispute are less rigorous for the subsidising Member than those provided in the SCM Agreement. But they are no less "encompassing". Formally, the relationship between the SCM Agreement and Article III of GATT 1994 is identical to the relationship between Article XVI of GATT 1947 and Article III of GATT 1947. The mere fact that the remedies against subsidies have been strengthened in the SCM Agreement is not a sufficient reason to conclude that Article III no longer applies to subsidies.

5.285 The fact that the SCM Agreement contains a definition of subsidies is also irrelevant. The absence of a definition of "subsidy" in GATT 1947 did not make Article XVI inapplicable, nor therefore prevented it from applying concurrently with Article III to the same measures. Furthermore, Article 1.1 of the SCM Agreement states very clearly that the definition of subsidy contained therein is only for the purposes of that Agreement.

(6) Article 32.1 juncto Footnote 56 of the SCM Agreement confirms that the SCM Agreement does not exclude the application of GATT Article III to subsidies

5.286 If, as claimed by Indonesia, the WTO Agreement had rendered GATT Article III inapplicable to subsidies, one would expect to find some indication in the SCM Agreement of the drafters' intention to introduce such a fundamental change with respect to the situation existing under GATT 1947. Yet, the SCM Agreement does not contain the slightest trace of such intention.

5.287 To the contrary, Article 32.1 juncto Footnote No 56 of the SCM Agreement indicates that the drafters of the WTO Agreement expressly envisaged the continued application of GATT Article III to subsidies covered by the SCM Agreement.

5.288 Article 32.1 of the SCM Agreement reads as follows:

5.289 Footnote No 56 to this paragraph then states that:

5.290 The obvious purpose of Article 32.1 is to prevent Members from taking action against subsidies on the basis of GATT Articles VI (to the extent that its provisions concern subsidies) or XVI, independently from the more precise rules laid down in the SCM Agreement. GATT Article III is not a provision "interpreted" by the SCM Agreement but, instead, one of the "other relevant provisions" to which reference is made in footnote No 56. Thus, in conformity with that footnote the SCM Agreement does not preclude the Community from taking action under Article III against a subsidy covered by the SCM Agreement.²²⁹

To Continue with Indonesia's interpretation would lead to an unjustified relaxation of the rules.

²¹⁴As noted by the Panel Report on United States - Measures affecting Alcoholic and Malt Beverages (adopted on 19 June 1992, BISD 39S/206, at para 5.8)

²¹⁵ Indonesia contends that neither previous GATT Panel Reports nor the Appellate Body Report on Canada - Certain Measures Concerning Periodicals (adopted on 30 June 1997, WT/DS 31/AB/R) have focused or analysed the last sentence of this citation. This is arguably true but irrelevant. That sentence confirms the proposition that Article III and Article XVI are not mutually exclusive: the mere fact that a measure is a subsidy falling within Article XVI does not exclude the application of Article III and, conversely, the application of Article III does not exclude the application of Article XVI.

²¹⁶ E/CONF.2/C.3/6, p.17; E/CONF.2/C.3/A/W.32, page 2.

²¹⁷ Panel Report on United States - Measures affecting Alcoholic and Malt Beverages, adopted on 19 June 1992, BISD 39S/206, at para 5.12.

²¹⁸ Appellate Body Report on Canada - Certain Measures concerning Periodicals, adopted on 20 June 1997, WT/DS 31/AB/R.

²¹⁹ Id., at p. 34.

²²⁰ Panel Report on United States - Measures affecting Alcoholic and Malt Beverages (adopted on 19 June 1992, BISD 39S/206, at para 5.10), reproduced in Appellate Body Report on Canada - Certain Measures concerning Periodicals, WT/DS 31/AB/R, p. 34.

²²¹ The lex specialis rule has never been invoked by prior Panels or by the Appellate Body in order to decide on the relationship between GATT 1994 and another Agreement contained in Annex 1A. The Panel Reports on EC - Regime for the Importation, Sale and Distribution of Bananas, examined the relationship between the GATT, on the one hand, and the TRIMs Agreement and the Agreement on Import Licensing Procedures, on the other hand, exclusively in light of the General Interpretative Note, even though, having regard to the greater degree of specificity of the obligations they impose, the two latter agreements are arguably lex specialis with respect to the GATT. According to the Panel, those two agreements and the GATT were "equally applicable" to the measures at issue in the absence of a "conflict" within the meaning of the General Interpretative Note. (See e.g. WT/DS27/R/USA, adopted on 25 September 1997, at paras 7.152.- 7.158)

The Report of the Appellate Body in the same case (WT/DS27/AB/R, adopted on 25 September 1997, at para 204) hold that:

Thus, the Appellate Body ruled that "both" Article X of GATT and the Licensing Agreement applied to the measures and that the latter should have been applied "first", and not "instead of" GATT Article X, as the lex specialis rule would have required.

²²² The relationship between GATT Article III:4 and the SCM Agreement is similar to that between the GATT and the GATS as described by the Appellate Body in the following passage of its Report on EC - Regime for the Importation, Sale and Distribution of Bananas (WT/DS27/AB/R, adopted on 25 September 1997, at para 221):

²²³ In addition, Article A.1 (a) (1) (iv) of the SCM Agreement refers to the hypothesis where a Government makes payments to a funding mechanism or entrusts or directs a private body to carry out one or more of the types of functions illustrated in (i) to (iii).

²²⁴ E/CONF.2/C.3/6, p.17; E/CONF.2/C.3/A/W.32, p.2.

²²⁵ Panel Report on Italian Agricultural Machinery, adopted on 23 October 1958, 7S/60.

²²⁶ Thus, for instance, in Canada - Certain measures concerning periodicals, the application by Canada Post of more favourable postage rates for domestic periodicals was found to violate Article III:4. (Panel Report WT/DS31/R, at paras 5.31-5.44, as modified by the Appellate Body Report, WT/DS31/AB/R, adopted on 20 June 1997, at pp. 32-35).

²²⁷ Panel Report on United States - Measures affecting Alcoholic and Malt Beverages (adopted on 19 June 1992, BISD 39S/206, at para 5.9.

²²⁸ Id., at para 5.12

²²⁹ Article 32.1 and footnote No 56 of the SCM Agreement reproduce the wording of Article 19.1 of the Tokyo Round Code and footnote No 1 to that Article, with the only difference that the references in the latter agreement to "the General Agreement" have been replaced by references to the "GATT 1994". The official title of the Tokyo Round Code was "Agreement on the Interpretation and Application of Articles VI, XVI and XXIII of GATT". Moreover one of the recitals included in the Preamble to the Code referred expressly to the desire of the parties "to apply fully and to interpret the provisions of Articles VI, XVI and XXIII". Thus, it was indisputable that the provisions referred to in Article 19.1 of the Tokyo Round Code as being "interpreted" by the Code were Articles VI, XVI and XXIII; and that the "other relevant provisions" of GATT referred to in the footnote included inter alia Article III. During the last phases of the Uruguay Round, the title of the SCM Agreement was changed from "Agreement on the Interpretation and Application of Articles VI, XVI and XXIII" to the current one because it was thought that the SCM Agreement created rights and obligations which went beyond merely "interpreting" and "applying" those provided in GATT Articles VI and XVI (see Appellate Body Report on Brazil - Measures affecting desiccated Coconut, adopted on 20 March 1997, WT/DS22/AB/R, at p.17). Furthermore, unlike the Tokyo Round Code, the SCM Agreement has no Preamble. Article 32.1 and footnote No 56 were not adapted to take into account those changes, which has rendered their meaning somewhat less clear than in the Tokyo Round Code. Yet, there is no indication in the drafting history that the negotiators intended to give a different meaning to Article 32.1 and footnote No 56 from that which Article 19.1 and footnote No 1 to that Article had under the Tokyo Round Code. According to the EC's recollection of the negotiations, Article 32.1 and footnote No 56 were added to the Dunkel Text by the Secretariat, together with the other Final provisions, and adopted by the negotiators without discussion.