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World Trade
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WT/DS103/R WT/DS113/R
17 May 1999
(99-1924)
Original: English

Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products

Report of the Panel

(Continued)


(e) In- and Over-quota Milk and the Producers' Choice (Cont.)

4.116 Canada noted that the United States had stated that the amount of in-quota milk sold for export use exceeded that from over-quota sources. While it was true that in-quota export sales did exceed over-quota sales in 1995/96, by 1996/97 the two were in balance. Most recently, in the 1997/98 dairy year, with the growth of over-quota and the full use of the "sleeve" in domestic markets, over-quota export sales had begun to greatly exceed in-quota export sales. It was also suggested that over-quota production was actually in decline. The United States noted that there was a decline from 1995/96 to 1997/98. There was indeed a small decline between those two years but it was misleading to suggest that this was the general trend. 140 In fact, there had been substantial growth the previous year and an even greater increase in 1997-98. It had also been suggested that growth in over-quota production was the result of the reduction of MSQ. Yet this was equally invalid. The growth in over-quota had greatly exceeded any reduction in MSQ. 141

4.117 Canada noted that the Complainants assumed that when products were exported at lower prices than those same products would command in the home market, there had to be a subsidization of the lower-priced exported products through profits obtained on the domestic market. Canada rejected these arguments. The Complainants had offered no evidence or explanation of why, in the absence of government direction or without the linking of domestic sales quota to export performance, producers would give away their profits from domestic sales in order to make unprofitable export sales. Indeed, they had failed to demonstrate any incentive to finance export sales from domestic profits. This argument was based on an assumption that milk producers behaved irrationally, or that governments somehow, in some unexplained way, forced them to reduce their net profits to engage in export sales. Canada argued that as a result of the supply management system and the presence of border protection, there were two very different markets: (i) a limited domestic market allocated to producers via quotas; and (ii) an open international market available to any producer willing to supply under conditions prevailing in that market. There was nothing in the Canadian milk marketing system that forced producers to supply the international market if they did not want to do so. The Complainants had failed to provide any evidence supporting the existence of any such mandatory performance requirement imposed on Canadian producers that would confer a benefit to exporting processors. Hence, Canada argued that the decision to produce or not to produce was one made on the basis of the same criteria that every commodity producer, indeed, any business person would make - the enhancement of the producer's net profits. The only reason for Canadian producers to sell products for the export market was because they could do so profitably. The protection of the domestic market afforded by tariffs did not alter this basic fact.

4.118 In respect of the price difference between OEP sales and Class 5(e) sales, Canada emphasized that the price difference between OEP sales and Class 5(e) sales stemmed from the commercial terms of the contract under which producers produced OEP milk. In OEP transactions, both the volume of milk supplied to the processor by the individual producer and the price paid for that OEP milk by the processor were contractually negotiated well in advance of the milk production with a view to fulfilling a pre-planned export contract made by the processor with a foreign buyer. By way of contrast, Class 5(e) milk sales were not pre-planned. Class 5(e) milk was normally used in dairy products sold on international spot markets. The pre-planned nature of an OEP transaction provided the processor with a secure supply of milk, an assured level of plant utilization and a guaranteed export sale price for a transaction identified in advance for its superior returns. For this assurance of supply, processors were willing to pay a premium for OEP milk. Canada argued that these market characteristics would exist even if producers negotiated Class 5(e) sales prices on their own or through their producer boards rather than using the CDC as a collective sales agent. As for the matter of processor margins, OEP processor margins were commercially confidential to the individual processor and were not made known to the producers, the producer boards or the CDC.

4.119 Canada argued that over-quota and OEP production came down to a matter of individual producer choice, as was illustrated by the dairy producer leaders who were CMSMC representatives and members of the Board of Directors of Dairy Farmers of Canada. Some of those producer representatives simply aimed to fill their domestic quota and not to participate in export market opportunities through the production of over-quota or OEP milk. For example, the DFC Director for Saskatchewan, Leo Bertoin, had been 0.04 per cent over, 0.03 per cent under and 0.004 per cent over his producer quota for 1995/1996, 1996/1997 and 1997/1998, respectively. By way of contrast, the President of DFC, Barron Blois, a producer from Nova Scotia who was also a provincial spokesperson at the CMSMC, had actively participated in over-quota export opportunities made possible by changing his feeding programme to reduce cash costs. Mr. Blois had consistently been in an over-quota position since the Special Milk Classes Scheme was introduced and was currently producing 20 per cent above his producer quota. The DFC Director for New Brunswick, Jacques Laforge, who was also the provincial spokesperson for New Brunswick at the CMSMC, had only produced to the level of his domestic quota but had also actively concentrated on available OEP markets. 142

4.120 The United States noted that Canada's argument that producers collectively decided to produce for export as part of their determination of MSQ for the year was contradicted by Canada's experience in 1997. In 1997/98, the MSQ was set at the beginning of the year at a level that presumably built in a specific amount for planned exports, in the so-called "sleeve". However, Canada had stated that almost all of the sleeve had been used last year for the domestic market. Consequently, any decision to produce for export within in-quota production, based on the MSQ at the beginning of the year, simply had not been realized when the domestic marketplace required more milk. Instead, those producers received primarily domestic prices for almost all of their in-quota production. As had been noted, whether milk was classified as in-quota or over-quota was subject to a variety of factors, and especially the fluctuation of MSQ from year to year.

4.121 The United States emphasized the significant increase in MSQ for the 1998/99 year (see table under paragraph 4.31). This increase was the clearest evidence that the CDC/CMSMC had seriously misjudged domestic requirements in the previous year. The reduction in MSQ in 1997/98 also was in large measure responsible for the unusual change in the relative proportion of over-quota versus in-quota exports in that year. 143 Even if domestic consumption in Canada remained at the high levels enjoyed in 1997/98, the 1998/99 increase in MSQ would necessarily result in a significantly higher percentage of in-quota exports in the current marketing year. The United States submitted that the 1997/98 marketing year was an aberration with respect to the low level of in-quota milk that was used for planned exports or determined to be surplus. That situation was primarily a result of a reduction in MSQ that turned out to be totally unjustified by market circumstances. In this connection, the United States noted that this judgment error had been corrected for the 1998/99 marketing year as the MSQ for the current year had been readjusted to restore the full amount of this reduction and actually included an increase over the 1996/97 MSQ level. This should result in a decline in over-quota production. The restoration of MSQ to earlier levels no doubt was a result of milk producers' complaints that they were being compelled to sell milk at Class 5(e) prices by the reduction in MSQ in 1997/98 which bore no relationship to market conditions. The United States argued that this significant shift of MSQ highlighted the artificiality of the over-quota/in-quota distinction, and the inability of milk producers to quickly adjust to dramatic swings in the MSQ such as occurred between 1996/97 and 1997/98. In fact, the reduction in MSQ in 1997/98 of approximately 3 per cent, when factored with Canada's statement that only over-quota production by individual producers above the 105 per cent level could be considered to be deliberate (see Footnote 121), accounted for at least two thirds of all over-quota production during the 1997/98 marketing period. Thus, Canada's assertion that over-quota production reflected milk producers' deliberate decisions was belied by the very information that Canada had submitted.

4.122 Like New Zealand, the United States stressed that the designation of milk as "surplus" was essentially an arbitrary one. The Canadian system was predicated on the assumption that the domestic population would only consume so much butter, so much cheese, so much ice cream and yoghurt, etc., at desired price levels in a given year and that this translated into class prices for milk. However, many of these dairy products were storable. Therefore, the decision to designate milk as "surplus" was really a decision not to build domestic stocks of dairy products for later consumption. Processors resisted stock building because as stocks grew they exercised downward pressure on the prices at which processors could sell their dairy products, and processors' profit margins would be eroded as a result. Producers disliked stocks because dairy product stocks represented a quantity of milk that would not be required at a future date, i.e., milk production would have to be cut while Canadians consumed the products in stock. Canada's solution was to export the surpluses using subsidies, and thereby maintain both high domestic price and production levels.

4.123 The United States refuted Canada's comparison of how prices were established under the OEP versus under Class 5(e) milk (paragraph 4.118). Canada's own explanation supported the conclusion that the Special Class prices were particularly low, given the international dairy marketing conditions. Canada was over-simplifying the commercial context of these sales. While Canada contended that OEP prices could be higher, in part, because they generally involved advance purchases of milk and, therefore, established a secure source of milk for the processors - Canada had earlier stated that many of the export transactions under Special Class 5(e) involved repeat sales involving the same exporters and international customers. If that was true, then the distinction that Canada now attempted to draw between OEP and Class 5(e) sales lacked a factual foundation.

2. "Export Subsidy" - the Interpretive Context

(a) The SCM Agreement and the Agreement on Agriculture

4.124 Canada argued that the definition of "export subsidies" for the purposes of the Agreement on Agriculture was found in Article 1(e) of the Agreement. This definition contained two components:

(a) the first component was "subsidies contingent on export performance";

(b) the second component included as export subsidies for the purposes of the definition the export subsidies specifically listed in Article 9 of the Agreement.

4.125 Canada further noted that Article 10.1 of the Agreement on Agriculture made an explicit reference to "(e)xport subsidies not listed in paragraph 1 of Article 9." Article 10.3 spoke of "no export subsidy, whether listed in Article 9 or not." Thus, Canada submitted that Article 10 in general, and Article 10.1 in particular, recognised the dual nature of the definition found at Article 1(e) of the Agreement. Article 10.1 applied only 144 with respect to "export subsidies" as defined in Article 1(e) other than those export subsidies that were included in the definition by virtue of having been explicitly listed in Article 9. What was left of the definition of "export subsidies" was the first component of the definition (i.e., "subsidies contingent on export performance" without including export subsidies specifically listed in Article 9 of the Agreement). Thus, the "other export subsidies" referred to in Article 10.1 meant "subsidies contingent on export performance", excluding the export subsidies specifically listed in Article 9 of the Agreement.

4.126 The term "subsidies contingent on export performance" itself had two components: (i) "subsidies" and (ii) "contingent on export performance". The term "subsidy" was not defined in the Agreement on Agriculture. Canada's position was that the prime contextual interpretative source for the meaning of the term "subsidy" was the definition of "subsidy" found in the SCM Agreement. 145 While the potential application of other sources for the interpretation of the term "subsidy" in the Agreement on Agriculture could not be excluded, the Complainants had not been able to identify any source having anything like the interpretative force of the definition of "subsidy" found in the SCM Agreement. Accordingly, "other export subsidies", as used in Article 10.1 of the Agreement on Agriculture, included "subsidies" (as interpreted in the context of the SCM Agreement) that were contingent on export performance, other than the export subsidies specifically listed in Article 9 of the Agreement on Agriculture.

4.127 Canada argued that the list of export subsidy practices found in Article 9.1 served two purposes in the Agreement on Agriculture. On one hand, it served as an exhaustive list of export subsidy practices that were subject to the reduction requirements set out in the Agreement. It also provided an illustrative list of export subsidy practices to be included within the definition of "export subsidy" in Article 1(e) of the Agreement. Both as an exhaustive list under Article 9 and as an illustrative list for the definition in Article 1, the text precisely reflected the common agreement by all Members regarding which practices should be considered "export subsidies" for the purposes of the Agreement on Agriculture. By the same token, the text also reflected where there was an absence of common agreement with respect to whether a particular practice should be considered to be an export subsidy (paragraphs 4.446 and following). In respect of criteria for export subsidies relating to differences between export and domestic prices, no reference could be found amongst the items listed in Article 9.1, with the exception of Article 9.1(b). The fact that a reference to domestic and export prices was included only with respect to paragraph (b) of Article 9.1 suggested that the negotiators could agree to such a reference only with respect to Article 9.1(b). 146

4.128 Canada emphasized the importance of the origin and character of the definition of a "subsidy" in the SCM Agreement. The SCM Agreement achieved what had not been possible during the life of the GATT 1947: a definition for the term "subsidy". This definition reflected a compromise reached by the negotiators in the Uruguay Round. As such, it reflected the practical realities of negotiations and represented a statement of what, by the end of the negotiations, the negotiators had been able to agree would be a "subsidy" for WTO purposes. It followed, therefore, that any measure or practice that did not fall within the terms of the definition could not be considered to be a subsidy for WTO purposes, regardless of any other conceptions or proposals as to what ought to constitute a "subsidy". Canada argued that it was not suggesting the agreed definitions of "subsidy" and "export subsidy" were perfect conceptions. There was no doubt that many WTO Members would prefer amendments in pursuit of their own policy objectives preferences. Perhaps proposals would be brought to the negotiating table for the next round of WTO negotiations. What the Complainants could not be allowed to do was to create an effective alteration of the negotiated texts through litigation.

4.129 New Zealand claimed that sources relevant to the interpretation of the word "subsidy" were: the Agreement on Agriculture, which provided the immediate context for the interpretation of the term "subsidy", and subsequently, the broader context of the WTO. The latter included, in particular, the SCM Agreement together with its Illustrative List of Export Subsidies, GATT 1994 and WTO/GATT practice.

4.130 New Zealand argued that in the present case, the question of the meaning of the term "subsidy" arose on two occasions: in the interpretation of Article 9.1(a) which referred to "direct subsidies"; and in the interpretation of Article 10 which referred to "export subsidies ... applied in a manner which results in, or which threatens to lead to, circumvention ... ". In each case, the question had to be asked what constituted a subsidy. New Zealand contended that the answer to this question had to be sought initially in the context of the Agreement on Agriculture and then more broadly in the context of the WTO Agreements as a whole. In this regard, the particular relationship of the Agreement on Agriculture and the SCM Agreement, recognised by the Appellate Body in Brazil - Measures Affecting Desiccated Coconut 147 , meant that the SCM Agreement was clearly part of the context to be referred to within the meaning of Article 31 of the Vienna Convention on the Law of Treaties (the "Vienna Convention") when interpreting the Agreement on Agriculture. 148

4.131 However, referring to the SCM Agreement as part of the context for the interpretation of the concept of "subsidy" in the Agreement on Agriculture was not the same as simply fastening onto one definition from the SCM Agreement and treating it as if it were an overriding definition for the purposes of all of the WTO Agreements. In fact, reference to the SCM Agreement could include reference to the definition in Article 1, or to the Illustrative List of Export Subsidies in Annex I, or to parts of those definitions and lists. Reference could also be made within this broader context to what constituted a subsidy under GATT 1947 and under GATT practice.

4.132 In New Zealand's view Canada's approach in this case was based on a fundamental interpretative error. Rather than addressing the key issue of interpretation in this case - the meaning of the term "export subsidy" as used in Article 9.1 and Article 10 of the Agreement on Agriculture - Canada instead focussed on the meaning of the term "subsidy", and proceeded to argue that the exercise of interpretation of this term as used in the Agreement on Agriculture could be largely confined to a consideration of the definition of subsidy found in Article 1 of the SCM Agreement. Canada's failure to locate the interpretation of export subsidies within the Agreement on Agriculture resulted in its ignoring the rules of interpretation applicable to the WTO Agreements which had been endorsed by the Appellate Body, and in limiting the scope of the disciplines that were carefully negotiated in the Agreement on Agriculture. Canada was hence inviting the Panel to read into the WTO Agreements an extravagant interpretative relationship between the Agreement on Agriculture and the SCM Agreement, and to make broad pronouncements on the scope of the SCM Agreement that were not necessary for this dispute.

4.133 New Zealand argued that by its very wording Article 1 of the SCM Agreement was limited to that Agreement. The opening words of Article 1 were "For the purposes of this Agreement" (emphasis added). Article 1 went on to say, "a subsidy shall be deemed to exist if ..." (emphasis added). Hence, New Zealand argued that the drafters did not intend this to be a definition for all purposes; it was simply a listing of what was deemed to be a subsidy for the purposes of the SCM Agreement. Canada had, in New Zealand's view, interpreted the terms of Article 1 of the SCM Agreement in isolation and therefore ignored the specific context of the SCM Agreement itself. If Canada had interpreted Article 1 in the context of the SCM Agreement as a whole, it would have been forced to conclude that, in the context of a discussion on export subsidies, the meaning of Article 1 had to be read also in the light of the Illustrative List of Export Subsidies. Yet, in New Zealand's view, for Canada, the Illustrative List appeared to stand alone as a separate list of export subsidies having no necessary relationship to Article 1 of the SCM Agreement.

4.134 New Zealand further argued that there was nothing in the Agreement on Agriculture that incorporated the SCM Agreement definition. Indeed, the implication of Article 21 of the Agreement on Agriculture, which subordinated the provisions of GATT 1994 and the other Multilateral Trade Agreements in Annex 1A to the WTO Agreement to any contrary provision in the Agreement on Agriculture, was that if the Agreement on Agriculture was to be dependent on another Agreement, that dependency would have to be express. The fact that at the end of the implementation period agricultural export subsidies would be subject to the disciplines of the SCM Agreement, as contemplated in Article 13(c) of the Agreement on Agriculture, did not necessitate that there had to be a coincidence of definition between the two Agreements on what constituted a subsidy. New Zealand argued that the relevance of Article 21 of the Agreement on Agriculture was that it made plain that in the event of a conflict between the Agreement on Agriculture and another WTO Agreement, the Agreement on Agriculture was to prevail. In other words, if an export subsidy were to meet the terms of one of the sub-paragraphs of Article 9.1 (relating to the category of export subsidies subject to reduction commitments) but yet did not meet the definition of Article 1 of the SCM Agreement, it would nonetheless still constitute an export subsidy for the purposes of the Agreement on Agriculture.

4.135 New Zealand argued that to simply transpose the definition provided in Article 1 of the SCM Agreement made no sense within the context of the Agreement on Agriculture. Article 1(e) defined the term "export subsidies" as referring to "subsidies contingent upon export performance, including the export subsidies listed in Article 9 of this Agreement." At the outset, this was potentially a broader definition than Article 1 of the SCM Agreement because Article 9 subsidies were included within it whether or not they met the definition of subsidy in Article 1 of the SCM Agreement or any other definition. They were export subsidies by virtue of the definition in Article 1(e) of the Agreement on Agriculture. It made no sense to re-test them by reference to some other definition of subsidy.

4.136 New Zealand argued that in effect, the relationship between the export subsidies listed in Article 9.1 of the Agreement on Agriculture and the definition of export subsidies set out in Article 1 of that Agreement was similar to the relationship that existed in the case of the Illustrative List of Export Subsidies in Annex I of the SCM Agreement and Article 3.1 of that Agreement. These were export subsidies by definition and they did not need any further testing against a definition of subsidy or export subsidy set out in the respective provisions of the two Agreements.

4.137 New Zealand further argued that while the export subsidies listed in Article 9 of the Agreement on Agriculture were exhaustive of the export subsidies for which reduction commitments had to be entered by Members, they were also, by virtue of their inclusion in the definition of "export subsidies" in Article 1 of the Agreement on Agriculture, indicative or illustrative of the broader category of export subsidies referred to elsewhere in the Agreement. This, too, argued against an interpretation of the term "subsidy" in the Agreement that limited it to the specific requirements of Article 1 of the SCM Agreement. It also had implications for the determination of what constituted an "export subsidy" under Article 10 to which the non-circumvention provisions of that Article applied.

4.138 The United States argued that the term "export subsidy" was defined in Article 1(e) of the Agreement on Agriculture, although the term "subsidy" was not. Article 9 of the Agreement on Agriculture, however, set forth a non-exhaustive list of export subsidies. That list served to inform the meaning of the term "subsidy" for the purpose of the Agreement on Agriculture.

4.139 The United States stressed that the meaning of the term "subsidy" in the Agreement on Agriculture had to be determined in its context, including the other WTO Agreements and the GATT 1994; it was not governed either exclusively or primarily by Article 1 of the SCM Agreement. The United States maintained that Canada's argument that the SCM Agreement's definition of "subsidy" was the exclusive basis for discerning the meaning of that term for purposes of all the WTO Agreements, including the Agreement on Agriculture, disregarded the plain meaning of the opening words of Article 1 of SCM Agreement as well as the views of the Appellate Body. 149 The definition of "subsidy" in the SCM Agreement was relevant for purposes of interpreting the same term used in the Agreement on Agriculture, but it was not to be given more weight, however, than the provisions of the Agreement on Agriculture.

To continue with The Relevance of the Vienna Convention


140 Canada referred to the graphic attached as Figure 2 of Canada's Annex D.

141 Ibid.

142 Canada noted that Mr. Laforge filled 100.01 per cent of his quota in 1995-1996 and was currently at almost exactly 100 per cent of his quota. Mr. Laforge has participated in an OEP contract for the sale of evaporated milk to the Caribbean.

143 The United States referred to Figure 2 of Canada's Response to the First Set of Questions from the Panel.

144 Canada noted that the other instance in which Article 10 applied was with respect to non-commercial transactions but this application was not relevant in the present matter before the Panel (para. 4.258).

145 Canada agreed that the definition of "subsidy" in the SCM Agreement was not the "definition", in the technical sense, of "subsidy" in the Agreement on Agriculture.

146 Canada noted that the other provision involving domestic and export price differences in the context of export subsidies was Paragraph (d) in the Illustrative List to the SCM Agreement. In that instance, the example provided was extremely carefully limited to very particular circumstances in recognition of the far-reaching implications of the concept.

147 Appellate Body Report on Brazil - Measures Affecting Desiccated Coconut, (hereafter "Brazil - Desiccated Coconut"), WT/DS22/AB/R, adopted 20 March 1997, p.14.

148 New Zealand noted that the SCM Agreement was particularly relevant, as it contained a list of export subsidies which constituted the background against which the export subsidy provisions of the Agreement on Agriculture were negotiated.

149 The United States noted that the Appellate Body also recognized this relationship when it stated that "with respect to subsidies on agricultural products ... [t]he Agreement on Agriculture and the SCM Agreement reflect the latest statement of WTO Members as to their rights and obligations concerning agricultural subsidies." Appellate Body Report on Brazil - Desiccated Coconut, op. cit., p.13.