1. Introduction

5.1 Australia stated that as an agricultural exporter, and in particular, as a major exporter of dairy products Australia had a direct commercial interest in the outcome of the dispute at issue. As the export subsidy provisions of the Agreement on Agriculture were of major systemic importance to Australia, Australia's submission focussed on the question whether the delivery of cheap in-quota milk to manufacturers for export under Classes 5(d) and (e) provided export subsidies under the Agreement on Agriculture. ³⁶⁶

5.2 Australia claimed that the Special Milk Classes Scheme delivered export subsidies within the meaning of the Agreement on Agriculture. As a result Canada was in breach of its export subsidy quantity reduction commitments for butter, cheese and other milk products under the Agreement on Agriculture. It followed that Canada was in breach of its commitments under Articles 3, 8, 9 and 10 of the Agreement on Agriculture and Article 3 of the SCM Agreement.

5.3 Australia disagreed with the United States line of argument regarding the functional equivalence of Canada's new dairy regime with its former system of producer-financed levies, which appeared to fall under Article 9.1 of the Agreement on Agriculture. Australia contended that this was not a trade impact issue but one of rules and so such a line of argument was not relevant. The WTO Agreement did not prevent a Member from bringing itself into conformity with the rules by measures that could have similar trade and production impact. In Australia's view the new regime provided export subsidies under the WTO rules regardless of the status of previous arrangements.

2. Discussion

(a) Relationship between the Agreement on Agriculture and the SCM Agreement

5.4 Australia noted that the Agreement on Agriculture itself did not contain a definition of "subsidy". Accordingly, the context of the Agreement on Agriculture needed to be examined for guidance, i.e. the WTO Agreement, in particular Annex 1A. The generic agreement on subsidies in the goods sector was the SCM Agreement. In the absence of any other indication, normal rules of interpretation suggested that that definition should be taken for other agreements in Annex 1A of the WTO Agreement. Moreover, there were explicit legal linkages between the Agreement on Agriculture and the SCM Agreement. In particular Article 13 of the Agreement on Agriculture provided a temporary derogation from aspects of the SCM Agreement provided that the conditions set out therein were fulfilled. Article 3.1 of the Agreement on Agriculture specifically referred to commitments limiting subsidization. The SCM Agreement was the vehicle by which the subsidy was defined for goods under the WTO Agreement. Article 31 of the Vienna Convention underlined that the Panel needed to interpret the meaning of "subsidy" in its context which included the WTO Agreement as a whole and the SCM Agreement in particular.

5.5 On the issue of the relationship between Article 1(e) of the Agreement on Agriculture ³⁶⁷ (which provided guidance for what constituted an export subsidy under that agreement) and Article 5.1(a) of the SCM Agreement ³⁶⁸ , the ordinary meaning of these terms in the context of Annex 1A of the WTO Agreement would imply that the definitions were the same. If there were measures that fell under Article 3.1(a) of the SCM Agreement but not the definition of export subsidy under Article 1(e) of the Agreement on Agriculture, then they would not be covered by Article 13(c) of the Agreement on Agriculture. That would appear to lead to a result other than the intention of Article 13 of the Agreement on Agriculture and so be ruled out under Articles 31.1 and 32(b) of the Vienna Convention.

(b) Classes 5(d) and (e) under the Special Milk Classes Scheme constitute export subsidies

5.6 Where in-quota milk was provided to processors/exporters under Classes 5(d) and (e), this involved the Government, through its legislative arrangements, providing goods (i.e. milk) at prices below those prevailing in the domestic market. Thus the measure provided a subsidy under Article 1.1(a)(iii) of the SCM Agreement. In the alternative, this was a subsidy under Article 1.1(a)(iv) of the SCM Agreement. The measure provided a benefit to the processor/exporter concerned, since it received the raw material (milk) at a price that enabled it to export the processed product concerned. This supply of milk was contingent upon the export of the processed dairy product. Accordingly, the measure constituted a subsidy that conferred a benefit on the recipient and was contingent upon export performance. Thus it fell under Article 3.1(a) of the SCM Agreement. Accordingly, it was an export subsidy within the meaning of the Agreement on Agriculture (as well as the SCM Agreement) and so came under Canada's obligations under Articles 3, 8, 9 and 10 of the Agreement on Agriculture. In the alternative, if the Panel found that this measure fell under Article 3.1(a) of the SCM Agreement but was not an "export subsidy" within the meaning of the Agreement on Agriculture, then it would be prohibited under Article 3 of the SCM Agreement, since it would not receive cover from Article 13(c) of the Agreement on Agriculture.

5.7 Paragraph (d) of the Illustrative List of Export Subsidies in Annex I of the SCM Agreement underscored that the provision of low priced inputs could be an export subsidy. In addition, while the calculation issue was in respect of countervail, Article 14(d) of the SCM Agreement indicated that such a measure would be a countervailable subsidy. Article 9.1(a) of the Agreement on Agriculture through its reference to "payments-in-kind" made it clear that cheap inputs in lieu of cash were regarded as direct subsidies.

5.8 Australia noted that given that Canada's exports exceeded the commitments in its Schedule, it was irrelevant whether the measure fell under the types of export subsidies listed in Article 9.1 of the Agreement on Agriculture, since Article 10.3 of the Agreement on Agriculture placed the onus on Canada to show that it had not breached its commitments whether or not it fell under Article 9.1 of the Agreement on Agriculture.

5.9 Classes 5(d) and (e) of the Special Milk Classes Scheme were designed to make products for export competitive through the supply of cheap milk based on the export price of the exported product. The "world price" of the milk, which was calculated by the CDC (whether product was exported by the CDC or where there were exporter-initiated proposals for export), was below the price of the milk that would be commercially available to processors/exporters without the operation of the scheme. The "world price" was negotiated by the CDC with the processor or exporter. The prices in Class 5 were in fact on the individual components of milk (butterfat, protein, other solids). The CDC was constructing what it termed a "world price", which would appear not to be commercially available to producers without the operation of the Special Milk Classes Scheme. Australia noted that while Canada argued that processors/exporters conceptually had access to milk at world market prices under its Import for Re-Export Program, the price of obtaining and using such milk was not taken into account when the price of the Class 5(d) or (e) milk to the processor/exporter was determined and was more favourable. There appeared to be no connection between the price of imported milk conceptually available at the factory under the Import for Re-Export Program and the prices charged for milk under Classes 5(d) and (e). Accordingly, the measure provided milk at a price below an adequate level of remuneration contingent upon the export of the manufactured product and therefore would constitute an export subsidy, under both the Agreement on Agriculture and the SCM Agreement.

(c) Export Subsidies under Article 9.1 of the Agreement on Agriculture

(i) "Provision by governments or their agencies"

5.10 The Canadian Government, whether through the CDC or through the provincial marketing boards, played a clear role in the establishment and administration of the Classes 5(d) and (e) in the Special Milk Classes Scheme. The CDC was mandated under the CDC Act ³⁶⁹ to establish and operate the pooling of revenues from milk sales, to determine the percentage of total production represented by Classes 5(d) and (e) including in each province, and to calculate the "world price" for the purposes of Classes 5(d) and (e). Moreover, it was through the CDC that processors/exporters obtained a permit for cheap milk for dairy products for export. The requirement under Article 9.1(a) that the direct subsidies were provided by governments or their agencies was thereby met.

5.11 Australia did not agree with Canada's argument that in effect the Canadian dairy export regime was in some way not governmental. The regime for exports from in-quota milk under Classes 5(d) and (e) were an integral part of the Canadian dairy regime, which operated under legislative authority at both the Federal and Provincial levels. In the absence of legislative backing the scheme would not be able to operate.

5.12 In respect of Canada's claim that the permits issued by the CDC were recommendations to the marketing boards and that the CDC was not mandated to decide whether processors/exporters obtained product at world prices for export, Australia noted that the processor/exporter could not receive milk products at world prices without the permit issued by the CDC.

(ii) "Direct subsidies, including payments-in-kind"

5.13 Article 9.1(a) covered "direct subsidies, including payments-in-kind". The ordinary meaning of this phrase was that the provision of cheap goods was to be regarded in the same way as straight cash. Accordingly, since for Classes 5(d) and (e) the cheap milk was provided by the Government contingent on the export of the manufactured product, the measure fell under Article 9.1(a) of the Agreement on Agriculture. It would be inconsistent with the ordinary meaning of the phrase 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 convert the measure from being a subsidy.

5.14 Processors/exporters accessed cheap milk under Classes 5(d) and (e) for the export of dairy products, compared with access to milk to produce the same product for the domestic market, and so the measure met the requirement of Article 9.1(a) that the provision of direct subsidies was "to a firm, to an industry, to producers of an agricultural product ...".

5.15 Processors/exporters requested a permit to export product under the Special Milk Classes Scheme. Milk destined for Classes 5(d) and (e) for processing into export product had been determined by the CDC. Classes 5(d) and (e) had been established solely for the export of dairy products and the provision of lower priced industrial milk was related specifically to the export of that product. Processors/exporters did not have access to the lower priced industrial milk unless the dairy product was to be exported. The subsidy provided through the Classes 5(d) and (e) was therefore "contingent upon export performance".

5.16 Accordingly, the measure satisfied the definition in Article 9.1(a) of the Agreement on Agriculture.

(d) Article 3 of the Agreement on Agriculture

5.17 Australia argued that since the Special Milk Classes Scheme was an export subsidy within the meaning of Article 9.1 of the Agreement on Agriculture, Canada was in breach of Article 3.3 of the Agreement on Agriculture not to provide export subsidies in excess of its budgetary outlay and quantity commitments levels specified in Section II of Part IV of its Schedule and in breach of Article 8 of the Agreement on Agriculture not to provide export subsidies otherwise than in conformity with the Agreement and with the commitments specified in its schedule.

(e) Article 10 of the Agreement on Agriculture

5.18 In the alternative, even if it were found that the export subsidies provided under Classes 5(d) and (e) were not captured within the meaning of Article 9.1 of the Agreement on Agriculture, Australia argued that Canada would appear to be in breach of Article 10.1 of the Agreement on Agriculture. The object and purpose of Article 10.1 of the Agreement on Agriculture was to prevent the circumvention of export subsidy commitments. This was reinforced by Article 10.3 which placed the onus on an exporting Member to demonstrate that any exports in excess of its scheduled commitments were not subject to export subsidies. As noted above, in Australia's view the measure provided an export subsidy and so the onus was on Canada to demonstrate that it was not in breach of its export subsidy commitments.

(f) Article 3 of the SCM Agreement

5.19 The measure in question fell under Article 3.1(a) of the SCM Agreement. Since Canada was in breach of its export subsidy commitments under the Agreement on Agriculture, it did not receive cover through Article 13(c) of the Agreement on Agriculture, and so was in breach of Article 3 of the SCM Agreement. In the alternative, if the Panel found that the measure was not an export subsidy within the meaning of the Agreement on Agriculture but was an export subsidy under Article 3.1(a) of the SCM Agreement, then again Canada would receive no cover from Article 13(c) of the Agreement on Agriculture, and so would be in breach of Article 3 of the SCM Agreement.

B. Japan

1. Introduction

5.20 Japan, as both a producer and major importer of dairy products ³⁷⁰ , expressed concern in respect of the effect of Canada's measures on international prices of dairy products. Such measures could give rise to inappropriate competition within the global dairy market, which in turn would bring about negative effects on the domestic markets. Hence, Japan considered that it had a substantial trade interest in the current matter.

5.21 Japan considered that the export subsidies were highly trade-distortive and had therefore argued for their termination. As a result of the Uruguay Round Negotiations, the WTO Agricultural Agreement provided that the Members had to phase out export subsidies and prevent the circumvention of such subsidies.

5.22 In Canada, a gap between export prices of dairy products and the domestic prices was created by the Special Milk Classes Scheme. Japan noted that the exportation of Canada's dairy products had been expanding under this Scheme. Japan considered that Canada's Special Milk Classes Scheme was an export subsidy, or, in the alternative, resulted in or threatened to lead to the circumvention of Canada's export subsidy reduction commitments.

2. Legal Arguments

(a) Canada's Special Milk Classes Scheme provided an export subsidy within the meaning of Article 9.1(c) of the Agreement on Agriculture

5.23 Japan considered that Canada's Special Milk Classes Scheme fell into the category of an export subsidy within the meaning of Article 9.1(c) of the Agreement on Agriculture, and that the actual amount of dairy products exported from Canada exceeded the level set forth in its Schedule. Consequently, Japan believed that the measures at issue were inconsistent with Articles 3.3 and 8 of the Agreement on Agriculture.

5.24 Article 9.1(c) provided the following two conditions for export subsidies: (i) "payments on the export of an agricultural product"; and (ii) payments that were "financed by virtue of governmental action". Concerning the first condition of Article 9.1(c), the price reduction provided by the Special Class 5(d) was available only for the milk destined for the production of dairy products for export purposes. Indeed, this was in practice and economically-speaking nothing else but "payments on the export of an agricultural product". With regard to the second condition of Article 9.1(c), the Special Milk Classes Scheme was founded through the Comprehensive Agreement on Special Class Pooling, which was an Agreement between the federal and provincial governments and operated by the CDC, whose authority to do so was given by the CDC Act and which was amended in 1995. This meant that the system was operated "by virtue of governmental action". Therefore, Japan considered that the price reduction under the Special Milk Classes Scheme was an export subsidy within the meaning of Article 9.1(c) of the Agreement on Agriculture, and accordingly had to be subject to reduction commitments under that Agreement.

5.25 Japan further noted that under Article 5.3 and Article 8 of the Agreement on Agriculture, Members were obliged not to provide export subsidies on agricultural products in excess of the budgetary outlay and the quantity commitment levels specified in their Schedule, and not to provide export subsidies "otherwise than in conformity with" the commitments in their Schedule. Japan noted that the volume of Canadian exports had exceeded the level of its export subsidy commitments under the Agreement on Agriculture in respect of most of the dairy product categories. ³⁷¹ Hence, Japan claimed that the Canadian measure at issue, being an export subsidy provided for in Article 9.1(c), was not consistent with Article 3.3 and, accordingly, not consistent with Article 8 of the Agreement on Agriculture.

(b) By operating the Special Milk Class System, Canada circumvented or threatened to circumvent its export subsidy commitments

5.26 Japan argued that even if the Panel were not to find that the Special Milk Classes Scheme provided an export subsidy within the meaning of Article 9.1(c) of the Agreement on Agriculture, Japan still believed that Canada's Special Milk Classes Scheme was inconsistent with Article 10.1 of the Agreement on Agriculture. Article 10.1 provided that the export subsidies not listed in Article 9.1 were not to be applied in a manner which resulted in, or threatened to lead to, circumvention of export subsidy commitments. If the Panel did not find the Scheme was an export subsidy as provided for in Article 9.1(c), Japan considered that the Scheme constituted an export subsidy within the meaning of Article 1(e) of the Agreement on Agriculture. This was because access to lower-priced milk under Class 5(d) was permitted exclusively for the purpose of processing dairy products for export and was "contingent upon export performance".

5.27 Under Class 5(d) of the Special Milk Classes Scheme, processors of dairy products benefitted from the price reduction instead of foregoing revenue by the provincial government agencies. Such price reduction, within the meaning of Article 1(e), constituted a "subsidy", the interpretation of which was supported by the negotiating history on export subsidies.

5.28 Japan noted, in addition, that the apparent purpose of the Special Milk Classes Scheme was to avoid the consequences caused by the termination of the producer levy-based subsidies and to replace them with a system that would have precisely the same economic effect. In this regard, Japan believed that this system was "applied in a manner which results in, or which threatens to lead to, the circumvention of their export subsidy commitments" within the meaning of Article 10.1 of the Agreement on Agriculture.

(c) Canada was requested to bring the measures at issue into conformity with the Agreement on Agriculture.

5.29 Japan argued that while it was understandable that the Government of Canada needed to establish certain domestic measures for a stable supply of dairy products through a sound development of dairy farming, the policy objectives in themselves could not justify the introduction of export subsidies which, in the case at issue, were highly trade-distortive and inconsistent with the Agreement on Agriculture.

5.30 Japan respectfully requested Canada to realize its domestic policy purposes through measures consistent with the WTO Agreement, and, also requested the Panel to recommend to the DSB that Canada bring its measure into conformity with its obligations under the Agreement on Agriculture.

To continue with Interim Review

³⁶⁶ Australia's submission was limited to the issue of measures affecting dairy exports.

³⁶⁷ Article 1(e) of the Agreement on Agriculture: "'export subsidies' refers to subsidies contingent upon export performance, including the export subsidies listed in Article 9 of this Agreement;"

³⁶⁸ Article 3.1(a) of the SCM Agreement: "subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I;" [footnote in original omitted]

³⁶⁹ Australia noted that Paragraph 9(1) of the CDC Act indicated the delegation of the CDC powers, by agreement with a province or a Board, of the Commission's powers under paragraphs 9(1)(f)-(i).

³⁷⁰ Japan noted that, for example, Japan was the largest importer of trade in cheese: 24 per cent of the total imports in the world was shared by Japan (as reported in 1996 in the "Dairy Compendium" by the Australian Dairy Corporation) and Japan's imports of Canadian cheese amounted to 283 tonnes in FY1995 and 1,236 tonnes in FY1996.

³⁷¹ Japan noted that, for example, the volume of exports for butter in 1995/96 was 14,845 tonnes from Canada, the ceiling volume of which was 9,464 tonnes for the same period.