I. Introduction

1.1 This proceeding has been initiated by two complaining parties, the United States and New Zealand.

1.2 In a communication dated 8 October 1997 (WT/DS103/1), the United States requested consultations with Canada in accordance with Article 4 of the Understanding on Rules and Procedures Governing the Settlement of Disputes ("DSU"), pursuant to Article XXII:1 of the General Agreement on Tariffs and Trade 1994 ("GATT 1994"), Article 19 of the Agreement on Agriculture, Article 30 of the Agreement on Subsidies and Countervailing Duties ("the SCM Agreement") and Article 6 of the Agreement on Import Licensing Procedures with respect to export subsidies of Canada on dairy products and the administration by Canada of its tariff-rate quota for fluid milk and cream. The United States and Canada held consultations in Geneva on 19 November 1997 but these consultations did not result in a resolution of the dispute.

1.3 On 29 December 1997 New Zealand requested consultations with Canada pursuant to Article 4 of the DSU, under Article 19 of the Agreement on Agriculture and Article XXII:1 of the GATT 1994 with regard to Canada's Special Milk Classes Scheme. New Zealand and Canada held consultations on 28 January 1998 but these consultations did not result in a resolution of the dispute.

1.4 On 2 February 1998, the United States (WT/DS103/4) and on 12 March 1998, New Zealand (WT/DS113/4), each requested the establishment of a panel with standard terms of reference.

1.5 In its request, the United States claims that:

1.6 In its request, New Zealand claims that:

1.7 The Dispute Settlement Body (DSB) agreed to each of these requests for a panel at its meeting of 25 March 1998 (WT/DSB/M/44). The DSB further agreed that the two panels be consolidated as a single panel pursuant to Article 9.1 of the DSU with the following standard terms of reference:

1.8 On 12 August 1998, the parties to the dispute agreed on the following composition of the Panel:

1.9 Australia and Japan, and the United States in respect of the New Zealand claims, reserved their rights to participate in the Panel proceedings as third parties.

II. Factual Aspects

A. The Canadian Dairy Sector

1. General

2.1 In Canada, milk production is divided into two categories: fluid milk and industrial milk. Of all milk deliveries, approximately 40 per cent is processed into table milk and cream (fluid milk); the remaining 60 per cent is processed into dairy products such as butter, cheese, milk powders, ice cream and yoghurt (industrial milk). ¹

2.2 Dairy producers are individual farmers who are licensed to produce milk and sell it, through marketing boards, to dairy processors. The processors are made up of the dairies that process the raw milk for fluid or industrial use, as well as further processors who use the basic dairy components as inputs for other products (such as frozen pizzas, prepared flour mixes, and confectionery). The processors then sell the value-added product on the domestic market or export it on international markets.

2.3 In Canada, there are approximately 23,800 dairy farms which in 1996/97 produced 77.5 million hectolitres of milk, compared to 84,260 dairy farms which produced 75.5 million hectolitres of milk in 1974/75 following the introduction of supply management. ² Virtually all production of milk comes from farms that produce for both fluid and industrial markets.

2.4 While fluid milk in general is produced and consumed locally within each of Canada's provinces, industrial milk products move in significant volumes across provincial boundaries or are exported from Canada.

2.5 Quebec and Ontario are the most important dairy-producing provinces in Canada. Quebec is the largest producer of industrial milk, retaining close to 50 per cent of the national share of industrial milk, followed by Ontario with approximately 30 per cent. The dairy processing industry is also centred primarily in Quebec and Ontario.

2. Components of the Canadian Dairy Policy

2.6 The basic components of Canada's supply management system for industrial milk are:

2.7 Regulatory jurisdiction over trade in dairy products is divided between the federal government and the provinces. While the federal government has constitutional authority over inter-provincial and international trade, other aspects of production and sale of milk are under provincial jurisdiction.

2.8 The federal government pays a subsidy of C$3.04 per hectolitre for industrial milk produced to meet domestic requirements. To this point in time, this subsidy is being phased out with the subsidy reduction being passed on to the marketplace through support price adjustments. The subsidy is expected to be eliminated by February 2002.

2.9 The federal government maintains tariffs and tariff quotas on imported dairy products. The following table summarizes the base and final bound tariffs for selected dairy products as bound in Canada's WTO Schedule:

2.10 Low-rate tariff quota commitments are applicable to the following products and quantities: fluid milk (64,500 tonnes); cream - not concentrated (394 tonnes); concentrated or condensed milk or cream (12.7 tonnes); butter (1,964 tonnes increasing to 3,274 tonnes); cheese (20,412 tonnes); yoghurt (332 tonnes); powdered buttermilk (908 tonnes); dry whey (3,198 tonnes); other products of milk constituents (4,345 tonnes).

2.11 Canada operates an Import for Re-Export Program under the authority of the Export and Import Permits Act. ³ Under this programme permits to import dairy products on an Import Control List may be issued by the responsible Minister subject to such conditions as are described in the permit or in the regulations. There are no specific policy guidelines or administrative instructions with respect to this programme, which has been in operation for a number of years. Imports under this programme consist of storable and tradeable components of milk, such as skim and whole milk powders and butter. No permits for milk for manufacturing purposes have been requested by Canadian processors under this program, but fluid milk is imported under the program in retail packages for use on, or eventual re-export by, cruise ships passing through Canada.

3. The Canadian Dairy Commission (the "CDC")

2.12 The Canadian Dairy Commission is a Crown corporation established under the Canadian Dairy Commission Act (the "CDC Act"). ⁴ Its mandate is set out in the following way in the text of the CDC Act:

2.13 The powers of the CDC are set out in Article 9.(1) of the CDC Act (Box 1).

2.14 The CDC receives its funding from the federal government of Canada as well as from producers and from market transactions. ⁶ Its members (a Chairman, Vice-Chairman and Commissioner) are appointed by the federal government, and the CDC is accountable to the federal Parliament, reporting to the Minister of Agriculture and Agri-Food. ⁷

2.15 The CDC establishes a national target price for industrial milk, which is an amount deemed to be adequate for oducers to cover their costs and receive a fair return on their labour and investments. Using the target price as a basis, the CDC also establishes support prices ⁸ for butter and skim milk powder. ⁹

To continue with Provincial Milk Marketing Boards

¹ The raw milk provided by the farmer to the processor is usually broken down at the initial stage of processing into its basic "constituents" (cream and skim milk) or into "components" (such as butterfat, protein and other milk solids). The various types of fluid milk (e.g., 3.25 per cent, 2 per cent, 1 per cent) and cream are created by re-blending the cream and skim milk to the desired butterfat content level.

² 1996/97 Annual Report of the Canadian Dairy Commission and Agriculture and Agri-Food Canada: "Long Term Dairy Policy Consultation Paper" (May 1996).

³ Canada, Exhibit 35.

⁴ The abbreviation "CDC Act" refers to the CDC Act as amended.

⁵ CDC Act, Section 8.

⁶ 1996/1997 Annual Report of the Canadian Dairy Commission, pp. 26 and 28-29.

⁷ CDC Act, Section 4, establishes that: The Commission [CDC] is for all purposes of this Act an agent of Her Majesty in right of Canada.

⁸ Currently, support prices are only used by the CDC for programmes to buffer domestic supplies seasonally and, to a very minor extent regionally and between processors. This is done through Plans A and B. Under Plan A, the CDC maintains butter stocks to buffer the domestic market against seasonal supply fluctuations. Sales from stocks acquired under this programme in 1996-97 amounted to less than 1 per cent of butter disappearance. Under Plan B, processors may sell butter to the CDC on condition that they repurchase it within the year. Sales of butter covered by this programme amounted to 18 per cent of domestic disappearance in 1996-97.

⁹ 1996/1997 Annual Report of the Canadian Dairy Commission, under "Price Setting".