(a) Arguments of Brazil

6.174 Brazil states that in 1996, Technology Partnerships Canada ("TPC") "'was created to address the need by established companies in specific industrial segments to ensure that near-market products -- those with a high potential to stimulate economic growth and job creation -- actually reach the marketplace.'"³⁰⁶ According to Brazil, sectors eligible for assistance from TPC are "'environmental technologies, enabling technologies, and aerospace and defence industries'"³⁰⁷, although Brazil maintains that in reality TPC represents a captive financing opportunity for the aerospace industry generally and the regional aircraft industry specifically.

6.175 Brazil indicates that TPC's predecessor was the Defense Industry Productivity Programme ("DIPP"), under which subsidies to the Canadian aerospace sector totaled approximately Can$2 billion.³⁰⁸ Brazil quotes Canadian Industry Minister John Manley as emphasizing that despite the reference to "Defence," "'virtually all funding under the DIPP fund has been earmarked for civilian applications,'"³⁰⁹ and argues that DIPP in fact "'had been used primarily by aerospace companies . . .'"³¹⁰ Brazil argues that in launching TPC, the Canadian government created a programme which "'is really nothing more than a redesigned and renamed Defence Industry Productivity Programme,'"³¹¹ noting that Industry Canada announced that "'no new commitments are being made under DIPP,'" but that "'[a]ny future funding will be considered under the auspices of the new programme, Technology Partnerships Canada,'"³¹² and quoting TPC's annual report that TPC funding "'is intended to cover outstanding commitments under the Defence Industry Productivity Programme (DIPP) . . .'"³¹³

6.176 According to Brazil, TPC explicitly targets "'conditionally repayable investments'"³¹⁴ to projects that result in a high technology product for sale in "'export markets.'"³¹⁵ For Brazil, this explains the programme's extensive support for the Canadian aerospace industry, which according to Brazil is described by TPC itself as "'highly export oriented.'"³¹⁶ Brazil asserts that the overwhelming export orientation of the Canadian regional aircraft industry has been confirmed in the Clark Report, a study submitted separately by Brazil, which concludes that all CRJ sales, and all Dash 8 sales since 1992, have been for export.

6.177 In answer to a question from the Panel concerning the coverage of its claim regarding TPC, Brazil indicates that it is challenging all TPC and DIPP funding extended to the Canadian regional aircraft industry after 1 January 1995.

(b) Arguments of Canada

6.178 Canada argues Brazil's case against Technology Partnerships (TPC) appears to be based on an "export propensity" and "intent" interpretation of Article 3. Brazil argues that TPC contributions are subsidies that are "contingent, in law or in fact, on export performance" because the Canadian aerospace industry is an "export-oriented" sector, because exports in the sector are growing at 10 percent a year and because the "building of exports" was, along with job creation, one of the objectives of TPC.

6.179 Canada asserts that Brazil's arguments are based on an incorrect reading of the law and faulty methodology in analyzing the evidence. Canada argues that TPC is not contingent, in law or in fact, upon export performance.

2. Subsidy

(a) Arguments of Brazil

6.180 Brazil asserts that TPC transfers funds in the form of grants and loans on concessional terms to specified industries, including the civilian aircraft industry, specifically on a "'royalty basis,'" which for Brazil means that repayment will only occur if the underlying project achieves a certain degree of success as described by Brazil. In Brazil's view, as with any government-provided low (or interest-free) loan or grant, these funds confer an obvious benefit on the recipient; namely, the recipient has no down-side risk-- if the project is unsuccessful, TPC loans need not be repaid. Brazil argues that TPC is not compensated for the risk that it will not be repaid, or for the extended repayment period during which neither principal nor interest on TPC contributions to the Canadian regional aircraft industry are due. Brazil further argues that even if the Canadian government recovers its investment - which, according to Brazil, recent audits show that it does not do for most conditionally-repayable assistance granted to Bombardier, de Havilland and Pratt & Whitney -- its anticipated rate of return is approximately 1.76 per cent for the CRJ loan from TPC, and 3.02 and 3.31 per cent for the Dash 8 loans from TPC, figures well below that expected by a "'reasonable market investor'" (paras. 6.188-6.192)³¹⁷.

6.181 In response to a question from the Panel, Brazil stated its view that a loan that is conditionally-repayable on a royalty basis constitutes a subsidy under Article 1.1 of the SCM Agreement where, if the loan is repaid, the rate of return is such that the lender is not compensated for either the risk that it would have received no repayment or the extended repayment period during which neither principal nor interest are due. If compensated for these two factors, such a loan could be considered commercial. If the lender is not so compensated, the recipient is realizing a benefit by receiving access to funds at a rate not available on the market. For Brazil, TPC is not compensated for that risk, but rather takes an equity investor's risk in exchange for a secured creditor's rate of return.

6.182 Brazil argues that on 21 October 1996, TPC announced that it was providing a Can$87 million loan to assist the development of Bombardier's 70-seat Canadair Regional Jet project, known as the CRJ-700.³¹⁸ According to Brazil, the loan is conditionally repayable on a "royalty basis," which for Brazil means that the loan will be repaid only if the project generates profits.³¹⁹ Brazil asserts that Bombardier has as an historical matter failed to repay its conditionally-repayable loans from the Government of Canada, citing an April, 1996 Industry Canada audit of conditionally-repayable Canadian Government assistance to Bombardier which concluded that repayments amounted to a mere five per cent of funds received by the company.³²⁰

6.183 Brazil states that repayment, if any, of the TPC loan for the CRJ-700 project will therefore begin only after Bombardier realizes profit on the project, which it is not projected to do until it has sold 250 of the CRJ-700s, the first of which is scheduled for delivery in 2000.³²¹ Furthermore, Brazil argues, Bombardier CEO Laurent Beaudoin has estimated that the company must sell 400 of the CRJ-700s to enable it to pay back the principal amount of the loan, without interest.³²² Thus, according to Brazil, any return on TPC's investment would only begin to accrue with the 401st plane sold, and Brazil asserts that industry estimates predict that only approximately 25 of the CRJ-700s will be produced annually.³²³ Brazil also submits an article which, it indicates, reflects "industry forecasts" projecting that Bombardier will produce between 127 and 178 CRJs by 2005.³²⁴

6.184 Brazil asserts that assuming a "royalty rate" of Can$580,000 per aircraft,³²⁵ with 25 aircraft sold annually, TPC's expected rate of return on this loan is 1.76 per cent,³²⁶ a return which illustrates that TPC "investments" are nothing more than outright gifts. For Brazil, as a result of this rate of return, the Government of Canada on an annual basis is foregoing an extremely conservative minimum interest amount of Can$4,054,200 (based on the difference between the 1.76 per cent expected rate of return and an extremely conservative benchmark rate of 6.42 per cent for the 1997 Canadian 10-year bond).³²⁷ Brazil states that assuming a more realistic benchmark rate -- the rate a commercial investor would expect to achieve for such an investment, i.e., 16.91 to 21.92 per cent³²⁸ -- Canada is foregoing between Can$13,180,500³²⁹ and Can$17,539,200³³⁰ annually on this TPC loan.

6.185 Brazil emphasizes that these figures do not account for the fact that repayment of this loan will not even begin until the year 2011, after Bombardier has sold 250 of the CRJ-700s.³³¹ In the meantime, according to Brazil, Canada is foregoing altogether a return on its TPC "investments" in the CRJ-700, resulting in a delay, and therefore increased risk, that would generally translate into a demand for a higher rate of return once such return is actually paid. Brazil asserts that with this considerable delay, no reasonable market investor could be expected to accept TPC's expected rate of return of 1.76 per cent, noted above. Brazil argues that assuming the benchmark rate a commercial borrower would expect to pay for such an investment, i.e., 16.91 to 21.92 per cent,³³² the present value in 1998 of the benefit received by Bombardier from this TPC "investment" is between Can$94 million and Can$211 million.³³³

6.186 In response to a question from the Panel concerning why Brazil considers that TPC will only be repaid if the CRJ-700 project is profitable, Brazil argued that under the repayment plan described above, before it has to begin repaying the principal amount of the contribution, Bombardier must sell 250 planes, which, at approximately US $23 million³³⁴ per plane, would gross Bombardier $5.75 billion. To begin to pay TPC a return on the contribution, Bombardier must sell 400 planes, gross income on which would reach $9.2 billion. Bombardier has stated that developing the CRJ-700 cost it $645 million.³³⁵ The conclusion to draw from this information, according to Brazil, is that TPC will not even recover the principal amount of its contribution, let alone realize any return, until the CRJ-700 has achieved for Bombardier a very significant degree of success which one can reasonably deem "profitable."

6.187 Brazil states that on 17 December 1996, TPC announced that it was providing a further Can$57 million to Bombardier's de Havilland subsidiary to develop a 70-seat "stretch" version of its Dash 8 turbo-prop airplane.³³⁶ According to Brazil, this loan, too, is repayable only when and if the venture is ever profitable.³³⁷ Using calculations similar to those used with regard to the $87 million loan, Brazil estimates that TPC's expected rate of return (if any) is 3.02 per cent, which Brazil states is well below that which would be expected by a market investor.³³⁸ Moreover, citing to an Industry Canada list, Brazil asserts that de Havilland has a rather poor repayment history having repaid a mere one per cent of the Can$424 million in DIPP funds provided to the company.³³⁹ Assuming the asserted benchmark rate a commercial borrower would expect to pay for such an investment, i.e., 16.91 to 21.92 per cent,³⁴⁰ Brazil estimates that the present value in 1998 of the benefit received by de Havilland from this TPC "investment" is between Can$43 million and Can$77 million.³⁴¹

6.188 Brazil further argues that in January 1997, TPC announced a total investment of Can$147 million in Pratt & Whitney Canada, Can$100 million of which was targeted for work on the firm's 6,500 SHP PW150 turboprop engine, used in Bombardier's Dash 8 aircraft, all of which according to Brazil are destined for export.³⁴² Brazil characterizes Industry Minister Manley as emphasizing, in granting this funding, the crucial role played in the Canadian economy by export-oriented sectors such as the Canadian aerospace industry, quoting Minister Manley as stating that "[a]erospace is a crucial sector for Canada's economy, with exports growing at 10 per cent per year."³⁴³ Using calculations similar to those discussed with regard to the $87 million and $57 million loans, Brazil estimates TPC's expected rate of return at 3.31 per cent, which according to Brazil is well below that which would be expected by a market investor.³⁴⁴ As with Bombardier and de Havilland, Brazil states, Pratt & Whitney's repayment history is poor, indicating that of nearly Can$900 million in "direct cash subsidies" from the Canadian government since 1980, less than Can$100 million has been repaid.³⁴⁵ Assuming the benchmark rate which Brazil argues a commercial borrower would expect to pay for such an investment, i.e., 16.91 to 21.92 per cent,³⁴⁶ Brazil estimates that the present value in 1998 of the benefit received by Pratt & Whitney from this TPC "investment" is between Can$97 million and Can$182 million.³⁴⁷

6.189 In response to a Panel question as to the rate of return that a "reasonable market investor" in the civil aviation sector would expect, Brazil submits that its argument in the context of EDC regarding risk and return (para. 6.11) frames the issue clearly: investors in speculative grade bonds expect a return greater than 17 per cent.

6.190 For Brazil, another relevant benchmark is the particular return expected by Bombardier on its own investments. In Bombardier's case, Brazil states, the required pre-tax rate of return is Bombardier's weighted average pre-tax cost of capital, which Bombardier expects to achieve across all risk classes of its investments; that is to say, this rate represents the average return on Bombardier's investment in new aircraft development, capital equipment and structures, and other investments. Brazil states that Bombardier's after-tax cost of capital is 11 per cent.³⁴⁸ Applying a 35 per cent effective tax rate, Bombardier's pre-tax cost of capital is determined to be 16.9 per cent. According to Brazil, if Bombardier's investments fail to achieve this rate of return, then Bombardier fails to provide a return to its debt and equity holders sufficient to compensate them for the risk they bear in investing in Bombardier.

6.191 According to Brazil, the required cost of capital return for Bombardier is not constant across all investments. Certain investments are inherently more risky and, hence, should have a higher expected return to compensate for the additional risk. Development of a new airframe, such as the CRJ-700, certainly falls into this riskier class of investment.

6.192 Brazil states that economic studies report higher costs of capital for these types of research and development projects. For example, a Federal Reserve Bank of New York study of the cost of capital in the United States and other countries found that the required cost of capital return for R&D projects averaged 19.2 per cent, while the required cost of capital return for equipment and machinery with a physical life of 20 years yielded an average return of 10.6 per cent.³⁴⁹ Brazil notes that other researchers have found R&D to have an even higher rate of return, in the range of 25 per cent to 35 per cent.³⁵⁰

6.193 Brazil states that based on this analysis, the Finan Report concluded that the benchmark rate a commercial borrower would expect to pay for airframe development expenses is between 16.91 per cent, which is Bombardier's pre-tax cost of capital, and 21.92 per cent, which includes a five per cent risk premium to compensate for the risk normally associated with R&D investment projects, as discussed in the previous paragraph.

6.194 According to Brazil, other TPC "repayable investments" for the development of Canadian regional aircraft, all of which are destined for export, have been recently announced, although without enough detail to permit analysis of the precise rates of return to be expected by TPC. In April 1997, Brazil states, TPC announced a Can$12.7 million "repayable investment" in Allied Signal Aerospace Canada, a portion of which is targeted for development of the power management generating system for the Dash 8-400.³⁵¹ Brazil also states that in March 1998, TPC announced a Can$9.9 million "repayable investment" in Sextant Avionique Canada Inc., to be used for development of the avionics system for the Dash 8-400 and the flight control system for the CRJ-700.³⁵²

6.195 Brazil asserts that the most recent WTO Trade Policy Review of Canada lists TPC as one of a number of "'Selected federal subsidy programmes.'" Brazil considers it significant that the Report has identified TPC as a "'subsidy.'" Moreover, according to Brazil, the WTO identified the form of subsidy offered by TPC as "'grants,'" as opposed to certain other programmes identified as "'repayable contributions'" or "'conditionally-repayable'" contributions.

To continue with Arguments of Canada

³⁰⁶ Industry Canada website, "Technology Partnerships Canada" (emphasis added) (Exh. BRA-29).

³⁰⁷ Industry Canada website, "Technology Partnerships Canada -- How It Works" (Exh. BRA-30).

³⁰⁸ Canadian Taxpayers Federation study, "Corporate Welfare - A Report on Sixteen Years of Industry Canada Financial Assistance," 16 April 1998, at Tab 4 (Exh. BRA-31). This statement of total DIPP funding to the aerospace sector represents aggregate DIPP funds released to four Canadian companies, i.e., Bombardier, de Havilland, Pratt & Whitney Canada Inc., and CAE Electronics Ltd.

³⁰⁹ Hansard, House of Commons Debates, 14 March 1996, Oral Question Period, at 709 (Exh. BRA-32).

³¹⁰ "Superfund to boost science, technology: Federal budget to unveil $200-million pot for development of new products for export," The Globe and Mail, 5 March 1996 (Exh. BRA-33).

³¹¹ Id.

³¹² Industry Canada Response to Inquiry of Minister, Question No Q-30 by Mr. Schmidt, dated 19 March 1996 (Exh. BRA-34).

³¹³ TPC Annual Report 1996-1997, p. 20 (Exh. BRA-5).

³¹⁴ Id. at pgs. 5, 15.

³¹⁵ Industry Canada website, "Technology Partnerships Canada -- How It Works" (emphasis added) (Exh. BRA- 30). See also "Superfund to boost science, technology: Federal budget to unveil $200-million pot for development of new products for export," The Globe and Mail, March 5, 1996 (TPC contributions are to cover "the development costs of new products, particularly those destined for export." (Exh. BRA-33).

³¹⁶ TPC Annual Report 1996-1997, pgs. 5, 15 (Exh. BRA-5). TPC's Advisory Board, which includes among its members Bombardier Aerospace Group's President and Chief Operating Officer, maintains this support network by "provid[ing] expert advice on the vision and goals of TPC's programme." Id. at 23, 26.

³¹⁷ See Tables in Exhibit B of Finan Report.

³¹⁸ Industry Canada News Release, October 21, 1996 (Exh. BRA- 35).

³¹⁹ Id. See also Industry Canada definition of "conditionally repayable contribution" (Exh. BRA- 36).

³²⁰ Industry Canada audit report, included in Canadian Taxpayers Federation study, "Corporate Welfare Volume Two," 4 June 1998, at Tab 6, pgs. 57-61 (Exh. BRA- 37). Although the Canadian government, to preserve confidential information, heavily edited the report of the Bombardier audit before releasing it to the Canadian Taxpayers Federation, Bombardier's identity and its repayment level were not expunged.

³²¹ See Exhibit A, pgs. A.3-A.4 of Finan Report.

³²² Id.

³²³ Id.

³²⁴ Exh. BRA-92

³²⁵ Calculated as Can$87 million/(400-250), reflecting the fact that repayment will not begin until 250 jets have been sold, and will be paid in full when 400 jets have been sold. Exhibit A, p. A.4 of Finan Report.

³²⁶ Id.

³²⁷ Using the 1997 rate of 6.42 per cent for Canada's "10 Year and Over Federal Government Bond Yield to Maturity." (Exh. BRA- 38).

³²⁸ Exhibit B, Table B.6 of Finan Report.

³²⁹ ($87,000,000)(.1691-.0176).

³³⁰ ($87,000,000)(.2192-.0176).

³³¹ Exhibit B, Table B.6 and Exhibit A, pgs. A.3-A.4 of Finan Report.

³³² Exhibit B, Table B.6 of Finan Report.

³³³ id.

³³⁴ "Orders soar for Canadair jet", The Globe and Mail, February 20, 1997 (Exh. Bra-90).

³³⁵ Id. See also "Le Quitte où double de Bombardier," Commerce, December 12, 1996, pg. 3 (Exh. BRA-92).

³³⁶ Industry Canada, News Release, 17 December 1996 (Exh. BRA- 4).

³³⁷ Id.

³³⁸ Exhibit A, p. A.5 and Exhibit B, Table B.7 of Finan Report.

³³⁹ "Billions in Federal loans unpaid: Biggest aerospace companies return as little as 2 per cent of money advanced for technology development," The Globe and Mail, 13 June 1998 (Exh. BRA- 39).

³⁴⁰ Exhibit B, Table B.6 of Finan Report.

³⁴¹ Exhibit B, Table B.7 of Finan Report.

³⁴² See Clark Report.

³⁴³ Industry Canada, News Release, 10 January 1997 (Exh. BRA- 40).

³⁴⁴ Exhibit A, pgs. A.5-A.6 and Exhibit B, Table B.13 of Finan Report.

³⁴⁵ "As Bombardier takes off, Pratt descends: Diverging fortunes raise questions about subsidies," The Globe and Mail, 19 October 1998 (Exh. BRA- 41).

³⁴⁶ Exhibit B, Table B.6 of Finan Report.

³⁴⁷ Exhibit B, Table B.13 of Finan Report

³⁴⁸ J.P. Morgan Securities report, "Bombardier," 1 September 1998, pg. 10 (Exh. BRA- 76).

³⁴⁹ Federal Reserve Bank of New York, "Explaining International Differences in the Cost of Capital," Quarterly Review, Summer 1989, Table 2 (average for the years 1984 - 1988) (Exh. BRA-95).

³⁵⁰ See US Congressional Budget Office report on "Federal Investment in Intangible Assets" (July 1991) (Exh. BRA-96). See also Edwin Mansfield, "Appropriating the Returns from Investment in R&D Capital," in K. Cool, D. Neven, and I. Walters (eds.), European Industrial Restructuring in the 1990s (1992) (Exh. BRA-97).

³⁵¹ Industry Canada, News Release, April 25, 1997 (Exh. BRA- 42).

³⁵² Industry Canada, News Release, March 6, 1998 (Exh. BRA- 43).