(b) Arguments of Canada³⁵³

6.196 Canada confirms that there have been commitments, under the TPC programme, for repayable contributions of $87 million to Bombardier for the development of the CRJ-700; $57 million to de Havilland for the development of the Dash 8-400; $100 million to Pratt & Whitney for the development of the PW150 turboprop engine; $12.7 million to Allied Signal Aerospace Canada, a portion of which is for the development of the power management generating system; and $9.9 million to Sextant Avionique Canada inc., for the development of avionics systems. Canada states that in every case, these amounts have not been completely disbursed to the recipients, but that a contribution is disbursed in predetermined portions as milestones set out in the project's work programme are met.

6.197 Canada challenges Brazil's description of the repayment obligations under the TPC.³⁵⁴ According to Canada, royalty-based repayment is not tied to profits, but to sales: in the case of some contributions, such as the contribution for the CRJ-700, the royalties are related to the sales of the specific product that are to be developed under the project; with respect to other projects, although the contribution may be in respect of a specific product, royalties would be paid on the sales of a family of products that would be developed following the original project. Canada notes as an example that the contribution towards the Pratt and Whitney 150 engine, under which royalties are payable on the sales of the family of engines that may be developed based on the original engine. Finally, Canada states, if it is a process or a technology that is being developed - such as one related to fuel efficiency - then royalties would be due on the basis of the total sales of the recipient enterprise. Thus, Canada states, in no circumstance is profitability a criterion of repayment.

6.198 Regarding Brazil's reference to Canada's recent WTO Trade Policy Review, Canada recalls that this Trade Policy Review, dated 19 November 1998, was conducted pursuant to the Agreement Establishing the Trade Policy Review Mechanism (TPRM Agreement) contained in Annex 3 of the WTO Agreement. Section A(i) of the TPRM Agreement specifically provides that:

6.199 Canada notes that the information contained in the report concerning Canada's alleged subsidy practices was obtained from Canada's notification under Article 25 of the SCM Agreement.³⁵⁵ Article 25.7 specifically provides that:

6.200 For Canada, the Secretariat's description of a Canadian programme in a TPR review therefore has no relevance whatever for the purposes of dispute settlement.³⁵⁶ Canada further states that the notification referenced by Brazil is Canada's Notification of the Technology Partnership Programme, and not Technology Partnerships Canada. Canada states that according to the Notification (at page 15), the objective of the Technology Partnership Programme is "to provide support to enable Canadian small- and medium-sized enterprises to enter into partnerships with university laboratories to develop university research to the point where it can be exploited by industry." Canada notes that the TPR Review correctly describes Technology Partnerships Canada, the programme at issue in this dispute, in its paragraph 117.

6.201 Canada contends that TPC contributions usually constitute a portion - on average less than 30 per cent - of the eligible costs incurred by the recipient, that eligible costs are limited to research and development expenses, and that TPC contributions may not be made for costs associated with facilities or capital equipment. Further, Canada argues, these contributions are repayable, generally on a royalty basis tied to the market success of a project: the more successful a product, the higher its returns. In that sense, according to Canada, TPC contributions are investments rather than loans: the Government of Canada shares in the rewards of successful projects. Unlike debts, TPC returns are not limited to a fixed amount.

6.202 In response to a Panel request for full details on the terms and conditions for the provision and repayment of the funds provided by TPC for the five transactions identified (para. 6.195) Canada notes that it has not put in a defence regarding whether these contributions are subsidies within the meaning of Article 1 of the SCM Agreement. Accordingly, Canada indicates, to the extent that any documents are produced by Canada in response to this question of the Panel, they are provided to support Canada's submissions that the contributions at issue are not "contingent on export performance" within the meaning of Article 3 of the SCM Agreement.

6.203 With regard to the Panel's request for "commercial borrowing rates" for debt of comparable size, risk level and maturity, Canada submits that the relevant consideration for determining the rate of return for the TPC contributions in question was the Government of Canada's cost of funds, and states that at the time these transactions were entered into, Canada's long term bonds were yielding approximately 6 to 7 per cent³⁵⁷ According to Canada, TPC repayment terms are negotiated so that on a net present value basis they are cost-revenue neutral or better. Canada provides as business confidential information in response to a Panel question regarding whether it agreed with any of the rate of return calculations of the Finan Report a calculation of TPC's rate of return on this transaction, and stated that this was clearly above Canada's cost of funds of 6-7 per cent.

6.204 In response to a Panel request for full details and documentation on TPC contributions to Bombardier, CAE Electronics and Pratt & Whitney listed in the 1996-97 Public Accounts of Canada, Canada states that the figures in the Public Accounts detail disbursements actually made in respect of existing commitments, and that information requested by the Panel concerning the TPC contributions to Bombardier for the CRJ-700 was provided in Canada's answer to the Panel's question concerning this funding. With respect to the CAE Electronique contribution, Canada states that Brazil has made no allegation and adduced no evidence in respect of this contribution, and that Canada does not consider it appropriate to adduce evidence in response to an allegation that has not been made and a case that has not been established.

(c) Comments of Brazil

6.205 Brazil observes that in response to a question from the Panel, Canada has provided documents for only one of the five TPC grants challenged by Brazil, and that with regard to that grant, Canada has wholly or selectively redacted any and all information which could be at all informative to the Panel. Brazil submits that the Panel should adopt adverse inferences, presuming that all information withheld by Canada is inculpatory, and that each of the five TPC contributions to the Canadian regional aircraft industry challenged by Brazil constitute export subsidies under Article 3 of the SCM Agreement. In this connection, Brazil argues that Canada has failed to provide documents specifically requested by the Panel on the TPC contributions identified in the Public Accounts of Canada (para. 6.203), and Brazil therefore requests the Panel to adopt adverse inferences regarding these transactions.

6.206 In Brazil's view, the Panel should presume, from Bombardier's decision to permit disclosure of information regarding the $87 million TPC grant for the development of the CRJ-700, that permission to disclose information regarding the $57 million grant to its subsidiary, de Havilland, for the development of the Dash 8-400 was withheld because such information would prove incriminating.

6.207 Moreover, Brazil argues, Canada has selectively provided in BCI Tab 1 various pages - largely redacted - from certain market assessments, presumably to show that the potential market for the CRJ-700 is large enough to give some hope that TPC will one day recover its "'investment'" in the development of the aircraft. Brazil notes Canada's reply to a Panel question (para. 6.367) that Brazil's conclusions in the Finan Report concerning the market prospects of the CRJ-700 are "'unduly pessimistic,'" citing to what Brazil terms Canada's selective and incomplete excerpts from the market forecasts included in BCI Tab 1. Brazil states that Canada has left out a critical portion of these studies - projections regarding Bombardier's production capacity for the CRJ-700 - which make Brazil's and the Finan Report's conclusions regarding the near impossibility of Canada's recovery of its "investment" crystal clear, noting that Brazil submitted³⁵⁸ a report of the Forecast International study extracted in Canada's BCI Tab 1, and indicating that that forecast concludes that Bombardier is able to manufacture only 178 CRJ-700s over the next ten years, or by 2006.³⁵⁹ For Brazil, this is a perfect illustration of why the Panel should adopt adverse inferences, presuming that the information withheld by Canada is prejudicial to its position.

6.208 Additionally Brazil states, the December 1997 and July 1998 programme updates and the July 1998 programme forecast included in BCI Tab 1, along with the progress reports included in BCI Tab 2, are redacted to such an extreme degree as to make them utterly worthless. Brazil states that all schedules and reports contained therein are redacted in their entirety, and that Canada's claim regarding whether destinations are listed in the order book redacted from the July 1998 programme update, for example, is without any support, as the information which would permit the Panel to reach this conclusion has been redacted.

(i) TPC's anticipated or expected return is below market

6.209 Brazil recalls the documentation it submitted to demonstrate that commercial lenders to speculative borrowers (bonds rated CCC+ to C) as of the fourth quarter 1998 were requiring returns of at least 17 per cent (para. 6.110), and its argument that development of a new airframe, such as the CRJ-700, certainly falls into this risk class, and that investment therein therefore should yield a return commensurate with this risk (paras. 6.188-6.192) Brazil states that economic studies report higher costs of capital for these types of research and development projects. For example, a study by the Federal Reserve Bank of New York concluded 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 cent³⁶⁰, and 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.³⁶¹ As a result, Brazil argues, the Finan Report demonstrated 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.

6.210 Brazil argues that as a result of the structure of the TPC contribution, it is impossible for TPC to achieve this rate of return, or any rate of return even remotely compensating TPC for the substantial risk undertaken in making this contribution: first, if Bombardier were to deliver only 200 CRJ-700s, for example, TPC's return would be zero, and it would fail to even recover the principal amount of its contribution; second, only if CRJ-700 deliveries meet the most optimistic of market forecasts - which, as discussed above (para. 6.206), have been misrepresented by Canada in its reply - does TPC's return reach the figure offered by Canada in its reply to question 33 as the maximum rate of return; third, were Bombardier to sell these aircraft over a longer time horizon than ten years, TPC would fail to earn the return heralded by Canada, which is, according to Canada, the maximum TPC can earn; fourth, while TPC could suffer a negative return, its return on the upside is capped, no matter what Bombardier's actual success in the market is.

6.211 Therefore, Brazil submits, it is only under the most optimistic of forecasts that TPC gets back both the principal amount of its contribution, and earns the maximum return permitted by the contribution agreement concluded with Bombardier, and even this return fails to compensate TPC adequately for the risk involved in its "investment."

(ii) TPC's expected return - "expected" at the time the loan commitment was made - was insufficient, even under Canada's "cost of funds" test

6.212 According to Brazil, the risk inherent in TPC's $87 million CRJ-700 grant is not with the design or development stage of the project, noting Canada's statements (para ) that "'project risk was considered manageable in light of Bombardier's proven track record and because the technical risk was mitigated by the fact that this aircraft was a stretch version of an existing platform - the CRJ50'", and that the "'market risk was also manageable.'"

6.213 Brazil states that the risk inherent in TPC's $87 million CRJ-700 grant is attributable to two factors, the first of which (see para. 6.184) involves the lengthy delay before repayment of principal, let alone interest, even begins. According to Brazil, the documents provided by Canada in response to Panel questions do not in any way rebut this factor, which would motivate any reasonable market investor to seek returns well beyond those anticipated by TPC for this type of loan.

6.214 For Brazil the second factor concerns uncertainty surrounding the number of CRJ-700 aircraft that will be delivered. Brazil argues that Canada cites to selectively quoted market forecasts to conclude that the size of the potential market for 60-90 seat regional jets will support the projections memorialized in the contribution agreement with Bombardier, and that TPC's anticipated return is very sensitive to the number of CRJ-700 aircraft delivered per year, and states that there is wide variation in the projections for the total number of units of the CRJ-700 that will be delivered (see para. 6.206).

6.215 Brazil does not ask to engage the Panel or Canada over which forecast is better or more plausible, but makes the point that for TPC to earn its anticipated return, and to meet even Canada's own estimate of its cost of funds (six to seven per cent) everything must go exactly according to plan. According to Brazil, the rate of return cited by Canada as TPC's anticipated return is actually based on a market projection which lies at the upper end of a very wide range of forecasts. Brazil argues that if the number of CRJ-700s delivered per year slips below that projection, TPC would fail to achieve the six to seven per cent minimum return required to meet its cost of funds.

6.216 Brazil argues that therefore there is a critical shortcoming with Canada's justification or support for the rate of return it calculates. In Brazil's view, Canada simply shows that it may be feasible to achieve that return under ideal circumstances, but this is not what an investor would focus on in deciding what its anticipated return on an investment should be. For Brazil, the question is not which forecast of future CRJ-700 deliveries is more credible; rather, the question is what an investor would do when faced with uncertainty about the potential market size for the CRJ-700. In Brazil's view, the investor would not simply rely upon the highest possible value for unit deliveries and use that to justify the expected rate of return, but rather, faced with uncertainty over the number of future aircraft deliveries, would is compute an expected value for the future deliveries of the CRJ-700, using this information to determine the expected royalty stream and, in turn, the expected rate of return.

6.217 Brazil submits that given the range of equally credible forecasts of CRJ-700 annual deliveries, the expected value is the mid-point of the range. At that midpoint, Brazil argues, TPC's expected return on annual deliveries of CRJ-700s fails to meet the cost of funds threshold identified by Canada itself.

6.218 Regarding Canada's assertion that TPC does not grant lump-sum contributions, Brazil argues that whether the TPC contributions are disbursed as a lump-sum or disbursed over time, the result remains the same - a benefit is provided to the recipient, who gains access to a below-market source of funds. In this context, Brazil submitted a table (BCI Exhibit Bra-1) showing the cash flows associated with the $87 million TPC grant for development of the CRJ-700, calculated with the grant being disbursed both as a lump sum, and over time.

6.219 Brazil further argues that business confidential information submitted by Canada in connection with the $87 million contribution to Bombardier suggests that the repayment terms do not appear to be consistent with that set out in TPC's repayment policy. In this connection, Brazil discusses, in business confidential comments on Canada's 21 December 1998 replies to the Panel's questions, a number of examples of what Brazil considers to be departures from TPC's repayment policy in the case of this particular transaction. For Brazil, this begs the question whether the Canadian government departs from this policy in the case of grants to the Canadian regional aircraft industry.

To continue with Export contingency

³⁵³ See also comments of Canada and responses of Brazil on the Finan Report regarding TPC in Section VI.F.

³⁵⁴ This paragraph responds to Question 18 of the Panel to Canada.

³⁵⁵ WT/TPR/S/53, at 71.

³⁵⁶ Indeed, the description of TPC in the TPR itself is internally inconsistent: see WT/TPR/S/53. The description of TPC at page 69, para. 117 correctly describes TPC investments and repayment conditions. The reference to "Grants" in the Table on page 71 is to the Technology Partnerships Programme.

³⁵⁷ Exh. CDN-108

³⁵⁸ Exh. BRA-92

³⁵⁹ Another forecast cited in Exh. BRA-92, by the Teal Group, concludes Bombardier will manufacture only 127 CRJ-700s by 2005.

³⁶⁰ 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).

³⁶¹ 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).