(a) Outline

3.162 New Zealand claimed that the case at issue was about subsidies provided to exporters of dairy products who were granted access to milk for processing into products for export at prices lower than those charged for milk sold for processing into products destined for the domestic market. New Zealand emphasized that the subsidy was financed, not by way of a rebate funded by a direct levy on producers, but under a scheme that compelled milk producers to accept a lower price for milk designated for that purpose. Producers were the source of the financing of the subsidy, but the subsidy itself was provided to exporters. Both New Zealand and the United States claimed that the Special Milk Classes Scheme were export subsidy practices listed in Article 9.1(a) and (c). As such, these practices were subject to reduction commitments under the Agreement on Agriculture. ¹⁸³

4.163 The United States noted that the Agreement on Agriculture, Article 1(e), defined export subsidies as "subsidies contingent on export performance, including export subsidies listed in Article 9 of this Agreement." Thus, two elements had to be shown to establish an export subsidy: (i) that a subsidy existed and (ii) that receipt of that subsidy was contingent on export performance. The United States claimed that the Special Milk Classes Scheme was a subsidy because it was a government mandated and controlled system that provided processors with milk at prices well below the comparable price for milk destined for the domestic market. In turn, these low prices allowed the processors to make export sales that would otherwise not be made and to earn "assured margins" on such sales pursuant to the CDC's calculation of the net return to the dairy producer. The subsidy was contingent on export performance because the lower prices could only be obtained for export sales.

4.164 Canada emphasized that Article 1 of the Agreement on Agriculture defined "export subsidies" to be "subsidies contingent upon export performance, including the export subsidies listed in Article 9 of this Agreement." (emphasis added) Hence, if there were either an export subsidy listed in Article 9 or a subsidy contingent on export performance, there was an export subsidy for the purposes of the Agreement on Agriculture. However, as the sales of milk at differing prices for domestic and export markets, and, in particular, sales of milk under Special Classes 5(d) and (e), did not constitute a "subsidy" pursuant to the definition of the SCM Agreement, it followed that these sales could not constitute a subsidy for the purposes of the Agreement on Agriculture. ¹⁸⁴ Therefore, by definition, such sales could not constitute an "export subsidy" within the meaning of the definition in Article 1 of the Agreement on Agriculture. Canada further claimed that the practices at issue did not constitute an "export subsidy" within the meaning of any of the export subsidy practices described in Article 9.1 of the Agreement on Agriculture and, in particular, not within any of the practices cited by the Complainants.

(b) Article 9.1(a)

(i) The meaning of "direct subsidies, including payments-in-kind"

4.165 New Zealand argued that, interpreted in accordance with the ordinary meaning of the terms of Article 9.1(a), in their context, and in the light of the object and purpose of the Agreement on Agriculture, Classes 5(d) and (e) of the Special Milk Classes Scheme constituted the provision by a government agency of a direct subsidy to an industry contingent upon export performance. This direct subsidy was provided through the foregoing of revenue or through a payment-in-kind within the meaning of Article 9.1(a) of the Agreement on Agriculture.

4.166 New Zealand argued that Canada, in focussing on the word "subsidies" in Article 9.1(a) of the Agreement on Agriculture and interpreting it in isolation, removed it completely from its own context. The term used in fact in Article 9.1(a) was "direct subsidies, including payments-in-kind". There was no justification in the rules of treaty interpretation for taking words individually out of a phrase, giving them each a meaning and then reconstructing the phrase on the basis of those individual meanings. That was divorcing meaning from context completely.

4.167 New Zealand argued that the normal usage of the term "payments-in-kind" was in respect of a payment in a form other than money, such as goods or services. ¹⁸⁵ The provision of a production input at no charge would clearly be a payment-in-kind. The provision of a production input (milk) at a reduced price was no less a payment-in-kind. New Zealand maintained that Article 9.1(a) referred specifically to "payments-in-kind" as included within the ambit of the concept of "direct subsidies". In the present case, government agencies made milk available to processors for export under Classes 5(d) and (e) at lower prices. This was the alternative Canada had chosen to providing a money sum to compensate processors for export for having to purchase milk at the higher domestic price. The benefit of access to lower-priced milk was provided through the combined actions of the CDC and the provincial marketing agencies. Their actions made the provision of milk by producers at these lower prices mandatory. Through the operation of Classes 5(d) and (e), the government agency provided a subsidy through a "payment-in-kind" within the meaning of Article 9.1(a).

4.168 New Zealand argued that the foregoing of revenue was well recognized as a form of subsidy, ¹⁸⁶ a common example being the foregoing of revenue through the remission of taxes. Thus, the ordinary meaning of the term "subsidy" in Article 9.1(a) included "revenue foregone". New Zealand noted that this was further illustrated in Article 9.2 which provided that in determining export subsidy commitment levels in Members' Schedules "revenue foregone" was to be treated as a subsidy. Article 9.2 provided in sub-paragraph (a)(i) that the "budgetary outlay reduction commitments" made by Members in respect of the subsidies listed in Article 9.1 shall in any year constitute the maximum level of expenditure for such subsidies. Article 1(c) of the Agreement on Agriculture defined "budgetary outlays" as including revenue foregone. Since revenue foregone was to be included in calculating levels of reduction commitments, it also had to be included in the concept of a subsidy for which reduction commitments were to be made. Thus, Article 9.2 made clear that the concept of "revenue foregone" was included within the scope of the subsidies listed in Article 9.1.

4.169 New Zealand noted that this conclusion was confirmed by reference to the negotiating history of the export subsidy provisions of the Agreement on Agriculture. The de Zeeuw Text contemplated that states would table lists of "financial outlays and revenue foregone" in respect of subsidy practices. ¹⁸⁷ Similarly, the Modalities for the Establishment of Specific Binding Commitments under the Reform Program (the "Modalities document") ¹⁸⁸ in the context of export subsidy reduction commitments stated that "the expressions 'outlays' or 'expenditure' shall, unless the context otherwise requires, be taken to include 'revenue foregone'." ¹⁸⁹ There had therefore been no doubt that revenue foregone was contemplated as a subsidy that would be subject to export subsidy disciplines.

4.170 New Zealand maintained that its understanding of the interpretation of Article 9.1(a) was confirmed by reference to the preparatory work in the negotiation of that article. From the outset it had been understood that mechanisms to shield exporters from having to pay high domestic prices would be regarded as export subsidies. The text of the "Generic Criteria" produced as a basis for considering export competition issues in the negotiations spoke of any form of subsidy which resulted "in the sale of such products for export at a price lower than the comparable price charged for like products to buyers in the domestic market." ¹⁹⁰ The "Illustrative List of Export Subsidy Practices", set out to give specific content to that Generic Criteria, included what subsequently became Article 9.1(a).

4.171 New Zealand argued that negotiating history made it clear that providing inputs at a lower price for export constituted a direct subsidy contingent upon export. The means by which the subsidised input was provided was not material. It could be through a transfer of money or it could be through revenue foregone. It could be viewed simply as the foregoing of revenue or it could be viewed as a "payment-in-kind". Regardless of the characterisation given, it constituted a direct subsidy captured by the terms of Article 9.1(a).

4.172 New Zealand argued that the ordinary meaning of the terms of Article 9.1(a), read in the particular context of Article 9 as well as in the broader context of the Agreement on Agriculture and the WTO subsidies regime as a whole, was that a government-mandated scheme whereby milk was made available by a government agency for the production of dairy products for export at prices that were lower than the prices for milk from the same agency for the production of comparable domestic products constituted a "direct subsidy" that was "contingent on export performance". Thus, the foregoing of revenue or the provision of a "payment-in-kind" by government agencies on milk provided to processors under Classes 5(d) and (e) was a subsidy within the meaning of Article 9.1(a) of the Agreement on Agriculture.

4.173 New Zealand argued that it was the lack of choice between supplying the domestic or the export markets which lead producers to forego revenue (addressed in paragraph 4.93 and following). The decision to place milk in one "market" rather than the other was not made by the producer. The decision that the domestic market was satisfied and that, accordingly, milk had to be classified into Special Class 5(d) or 5(e) was made by government. Rational, profit-seeking producers, however, would - if they had the choice - supply their milk to the higher-priced domestic market (even although the influx of more milk into that market may ultimately have the effect of lowering prices). But the decision that they may not do so was made for them. Hence, the distinction between domestic and export markets was government-created: it was, indeed, a legal fiction created by Canada. With regard to in-quota milk, producers collectively forewent revenue by being forced to accept a lower in-quota price by virtue of export sales being pooled with higher-priced domestic sales. With regard to over-quota milk, individual producers forewent revenue by having no choice other than to accept the export price for that portion of their production which was ultimately deemed to be over-quota. Under the Special Milk Classes Scheme, the government of Canada obliged milk producers to forego the revenue they would otherwise have received from sales of milk at domestic prices in order to create an economic incentive for exporters to export. Producers were compelled to forego revenue and the benefit of this revenue foregone was passed on to exporters. Since both in-quota and over-quota milk were allocated to Class 5(e), the foregoing of revenue under Class 5(e) applied as much to over-quota as it did to in-quota milk.

4.174 New Zealand noted that under the old producer levy-based system, producers received the same gross price for all milk produced (both in-quota and over-quota) but were forced, by government regulation, to forego revenue by virtue of a levy to subsidise the cost of exports. The situation was little different under the Special Milk Classes Scheme. Producers were forced to accept a lower price for milk that was subsequently exported. In the case of in-quota milk the revenue received by a producer was reduced by pooling. In the case of over-quota milk, revenue was not pooled and the price was determined by the CDC and the provincial milk marketing agency on the basis of world prices. New Zealand pointed out that the fact that world prices were the benchmark should not obscure the fact that the decision to place milk in one "market" rather than the other was not made by the producer.

4.175 The United States argued that the Government of Canada, whether through the CDC or through the provincial governments, played a clear role in the establishment and administration of the Special Milk Classes Scheme. It was through the CDC that processors obtained a permit for preferentially priced milk for dairy products for export. In the absence of the federal and provincial government authority and legislation for the Special Classes, the processors would be paying the full price for milk. ¹⁹¹ The processors would not be receiving milk at an artificially reduced price tailor-made by the CDC to allow them to make export sales. ¹⁹² Thus the requirement under Article 9.1(a) that direct subsidies were provided by governments or their agencies was met.

4.176 The United States argued that Canada's construction of Paragraph 9.1(a) would make the reference to payments-in-kind meaningless. The Canadian argument was contrary to the principles of interpretation under customary international law and, in particular, those that required that the terms of an agreement be given effect, and that they be interpreted in good faith, in context and in light of their object and purpose. ¹⁹³ Article 9.1(a) covered "direct subsidies, including payments-in-kind". The ordinary meaning of the phrase "payments-in-kind" in the context of Article 9.1(a) was that the provision of artificially low-priced goods was to be regarded in the same way as straight cash. Accordingly, as Classes 5(d) and (e) provided milk at a reduced price contingent on the export of the manufactured product, the measure fell within Article 9.1(a) of the Agreement on Agriculture. It would be inconsistent with the ordinary meaning of the phrase "payment-in-kind" to suggest that the provision of goods without payment would be a subsidy, but that any level of payment, even though less than adequate remuneration, would not be an export subsidy. Moreover, the frequent statements by both industry leaders and Members of Parliament that the Special Classes would allow milk producers to share the "costs" of exports confirm that indeed the government was transferring value from the milk producers to dairy processors.

4.177 The United States argued, in respect of revenue foregone, that the Canadian position was premised on the idea that under Canada's milk marketing system producers could not sell milk into the domestic market that was designated for export as surplus milk. Yet, this division of markets into domestic and export segments was an artificial one and completely a construct of Canada. As New Zealand had stated, there were separate "markets" only because Canada had created a "special milk class" scheme and assigned the export of dairy products to Class 5. The United States recalled that milk was declared surplus to the domestic market in Canada pursuant to the discretion of the Canadian Dairy Commission. This was not a determination based on the operation of a free market. For instance, there was no determination of demand elasticities at different price levels. Instead, prices were maintained at rigid levels in the domestic market and if the market could not be cleared at a particular price level, there was not much latitude to reduce price to sell additional product domestically. Moreover, the declaration of a milk surplus was generally based on conditions within a province, usually without consideration of conditions in other provinces despite the fact that there was considerable movement of milk across provincial boundaries. The United States argued that Canadian consumers would use more milk if domestic prices were lower. Special Classes 5(a) through (c), offering lower priced milk to compete with certain imports, implicitly recognized this market principle. Milk sold at those lower Special Class prices allowed Canadian producers to capture additional sales. If that milk had instead been exported at the still lower Special Class 5(e) prices, there was no question but that the total revenue received by the milk producer would have been less, resulting in "revenue foregone".

4.178 The United States noted that the same principle was demonstrated by the controversy over the substitution of imported butter-oil for butterfat in products such as ice cream. The high domestic milk prices in Canada had caused processors to look for alternative products for inputs in fat-rich products such as ice cream. If milk were to be sold at lower prices in Canada, milk would retain such product markets. It was for this reason that a proposal had been made to create an additional Special Class to allow Canadian milk producers to be more price competitive with imports of butter-oil. The Canadian International Trade Tribunal, in its report relating to butter-oil imports, considered the possibility of Canadian milk producers simply selling the milk that was displaced by imports of butter-oil into world markets. In conducting an analysis of the impact of such action on Canadian milk producers, the Canadian Tribunal described the effects in terms of "revenue foregone" by the Canadian industry. ¹⁹⁴ Thus, this concept was not unfamiliar to the CITT, with its considerable knowledge of the Canadian milk marketing system.

4.179 Canada reiterated that sales of milk at differing prices did not constitute a "subsidy" as it was defined in Article 1 of the SCM Agreement. As the Agreement on Agriculture and the SCM Agreement had to be taken together, the definition of "subsidy" in the SCM Agreement was applicable to the term "subsidy" as it was found in Article 9.1(a). ¹⁹⁵ It followed that there was no "subsidy", whether direct or not, for the purposes of Article 9.1(a). (Canada's detailed arguments on the application of the SCM Agreement definition of "subsidy" to the measures in question are summarized beginning at paragraph 4.309.)

4.180 In respect of the matter of payments-in-kind, Canada noted that the United States argued that Canada's interpretation of Paragraph (a) would make the reference to payments-in-kind meaningless and New Zealand characterized a sale of dairy inputs at a reduced price as a payment-in-kind. Canada submitted that the Complainants had not clearly articulated what amounted to a payment-in-kind. Canada's position did not seek to make that expression meaningless but rather to give the expression its ordinary meaning. A payment-in-kind arose when a debt was satisfied by the provision of a good or a service rather than being paid for in money. For example, a government could impose a 5 per cent royalty with respect to a concession to drill for oil. If the government permitted that obligation to be discharged by the delivery to it of one barrel of oil for every twenty barrels extracted, that would be a payment-in-kind. In the case of the Canadian dairy system, payment was made for milk in the ordinary sense of the word. A market-based differential between payments was qualitatively different from a payment-in-kind. ¹⁹⁶

4.181 Canada noted that the Complainants sought to find a subsidy in Article 9.1(a) by claiming that there was "revenue foregone" (paragraphs 4.173 and 4.177). Canada submitted that even if the word "payments" were held to include "revenue foregone", there was no revenue for the producers to forego with respect to sales of milk for export use under Special Classes 5(d) and (e). In the context of commercial sales, revenue was foregone when the vendor chose to sell the product at a price lower than the price at which the vendor could have otherwise sold it. In other words, if a vendor chose to forego a sale into a higher-priced market in favour of a sale into a lower-priced market, then the vendor had chosen to forego revenue. ¹⁹⁷

4.182 Canada argued that "revenue foregone" implied a choice of markets, a choice foregone. Under the Canadian milk marketing system, milk could not be sold in the market for export uses if it was required for Canadian domestic requirements. Thus, sales of milk for export purposes at prices based on world market prices could not be made until there was no opportunity to sell milk into domestic markets at the higher domestic prices. This was a basic and rational approach in any commercial operation. Any milk sold for export uses was additional to the domestic demand. The sale of milk at world market prices - not always lower than domestic prices - therefore took place when milk producers in Canada could no longer place their products on the domestic market, and had therefore to try to obtain the highest prices possible in the alternative market, i.e., the market in Canada for milk for use in exports. Suggestions that Canadian milk producers somehow "forewent" revenue otherwise available to them in the domestic market demonstrated a serious misunderstanding of the Canadian milk marketing system.

4.183 Canada argued that rather than representing "revenue foregone", such sales represented revenue enhancement. Canadian producers could choose not to produce any milk in addition to domestic requirements. Accordingly, they could choose not to produce milk for use in export sales. They could choose to limit their revenues to the returns they would get from the domestic markets. Instead, by choosing to produce milk in addition to domestic needs, the returns from which would be based on world market prices, producers chose to try to enhance their total revenues. As a result, the only reasonable approach was indeed the approach adopted by the milk producers in Canada; to find a market in which the highest return was found for milk at any particular time. Thus, in the sale of milk at world market prices, revenue was not foregone but rather enhanced.

4.184 Canada argued that the fact that there was a domestic market and an export market was not a fiction but a fact of life. Canada rejected New Zealand's characterization that producers were "forced" by government to forego their own revenue. The record showed that the producers had collectively and individually chosen to market their product in the manner reflected by the present regime. New Zealand failed to explain how producers making these collective and individual decisions were "foregoing revenue" in the sense understood by Canada and the United States. In addition, it remained Canada's position that there was no revenue foregone, even to producers, when a person willingly sold a product in a market for the price that the market would bear for that product.

4.185 Canada noted that New Zealand built arguments on the basis of the Uruguay Round negotiating document entitled: Modalities for the Establishment of Specific Binding Commitments under the Reform Program (paragraph 4.169). Canada pointed out that the following injunction was found on the cover sheet of the document:

4.186 New Zealand argued - in respect of Canada's argument that the Special Milk Classes Scheme did not constitute a "payment-in-kind" within the meaning Article 9.1(a), because a payment-in-kind arose when a debt was satisfied by the provision of a good or a service rather than being paid for in money (paragraph 4.194) - that the suggestion that the existence of a debt was a prerequisite to any notion of payment-in-kind would render that concept, in the context of subsidies, completely redundant. If a debt was owed, the payment of it, or its discharge through a payment-in-kind, could not constitute a subsidy. It would simply be the re-payment of a debt. To the extent that Canada was suggesting that a payment-in-kind could never be a subsidy and could only be used in the context of the satisfaction of a debt, it was seeking to rewrite Article 9.1(a) to exclude the concept of "payment-in-kind" completely.

4.187 Since Canada's arguments that the Special Milk Classes Scheme did not meet the definition of the term "subsidy" and hence could not be a subsidy within the meaning of Article 9.1(a) of the Agreement on Agriculture were unfounded (paragraph 4.179), New Zealand's arguments on the applicability of Article 9.1(a) remained unanswered by Canada.

To continue with The meaning of the term "direct"

¹⁸³ The United States expressed its total agreement with the arguments presented by New Zealand regarding the applicability of Article 9 and 10 of the Agreement on Agriculture.

¹⁸⁴ Canada noted that Classes 5(a) to (c) were not contingent on export and that no suggestion had been made that they were contingent on export.

¹⁸⁵ New Zealand noted that The Dictionary of Canadian Law (Toronto, 1991) at p. 755 provided that a "payment-in-kind" meant "remuneration in the form of goods or services".

¹⁸⁶ New Zealand noted that Article 1 of the SCM Agreement included revenue foregone by a government within the definition of a subsidy (see Article 1.1(a)(1)(ii) for example).

¹⁸⁷ "The Framework Agreement on Agricultural Reform Programme" (MTN.GNG/NG5/W/170). (New Zealand, Annex 31)

¹⁸⁸ MTN.GNG/MA/W/24.

¹⁸⁹ The Modalities Document, para.2, Annex 8 (MTN.GNG/MA/W/24).

¹⁹⁰ MTN.GNG/AG/W/1/Add.10 at p. 1 (para. 2).

¹⁹¹ The United States noted that prior to the institution of the Special Milk Classes Scheme, dairy exporters paid full domestic prices for milk used in export, but were then rebated a portion of the purchase price to enable them to compete in world markets.

¹⁹² The United States understood that the CDC determined the price paid to the milk producer under Special Class 5(d) and (e) by calculating backward from a "world" price, netting out an assured margin, i.e., profit, for the exporting dairy product manufacturer.

¹⁹³ Appellate Body Report on US - Reformulated Gasoline, op. cit., p.23.

¹⁹⁴ United States, Exhibit 42.

¹⁹⁵ Canada noted the acknowledgement of the United States that the meaning of the word "subsidy" was substantially the same for the purposes of the Agreement on Agriculture and the SCM Agreement (paragraph 4.304).

¹⁹⁶ Canada noted that this explanation of its interpretation of the pression "payment-in-kind" was without prejudice to its position that there was no Article 9.1 export subsidy of any kind in this case.

¹⁹⁷ Canada noted that the United States had publicly stated that Canadian milk was sold to the international market at world market prices: FAS Online, "Dairy: World Markets and Trade - January 1998": "The US Challenges Canada's Dairy Export Subsidies and Import Protection", p. 2; "Dairy Trade by Selected Countries", p. 2. This was in contrast with the suggestions found in paragraph 40 of the United States Submission that Canadian exports were sold at prices "equal to or below world prices". Further, Canada noted again that since, under the Canadian dairy system, the ultimate decisions to produce for export lay with the dairy producers, they demanded that sales of such milk be made for the best available prices. To do otherwise would be irrational. (Canada, Exhibit 33)