VI. Interim Review

6.1 On 5 February 1999, the Panel issued its interim report to the parties. On 18 February, Canada and the United States requested the Panel to review precise aspects of the interim report, in accordance with Article 15.2 of the DSU. New Zealand did not seek review of any aspect of the interim report. Neither of the three parties requested the Panel to hold a further meeting. We subsequently allowed the parties to comment on the comments we received on 18 February. On 26 February, all three parties submitted such comments.

6.2 Canada suggested that certain corrections and additions be made to the descriptive part of our report. The complainants did not object to these corrections and additions. Where appropriate, we redrafted the relevant sections accordingly. Canada also noted that Table 2 in paragraph 2.41 of our report contains confidential data. We deleted the relevant data from the last column of Table 2, inserted an appropriate footnote regarding the availability of this data in any appeal proceedings, and expressed the indications we derived from this column in paragraph 2.41. We kept the remaining columns in Table 2 since the data contained therein was already made public by Canada in its notifications under the Agreement on Agriculture.

6.3 On the basis of factual comments received by Canada we also redrafted paragraphs 7.54 and 7.59.

6.4. We incorporated certain US suggestions in the descriptive part of our report. Other suggestions had already been taken into account as a result of US comments on the descriptive part of our report. In the light, inter alia, of Canada's objections to other US requests for review, we did not add language to paragraphs 7.10, 7.48 and 7.152 of our report.

6.5 The United States further suggested deleting the reference made in the interim report to the concept of "obiter dicta" in respect of our examination under Article 10 of the Agreement on Agriculture. We followed this suggestion (to which Canada did not object and with which New Zealand agreed) in order to clarify the matter. We stress, however, that our examination and findings under Article 10 are made in the alternative, i.e., in the event our findings under Article 9.1 should not be adopted and the DSB decides the dispute based on the alternative claims of violation of Article 10. Accordingly, we redrafted paragraphs 7.119, 7.136 and 8.1 and footnote 530

VII. Findings

A. claims of the parties

1. The Special Milk Classes Scheme

7.1 New Zealand and the United States claim that the volume of Canadian exports of certain dairy products, under a scheme known as "Special Milk Classes", exceeds Canada's export subsidy commitments. Pursuant to this scheme, milk is classified into five Classes according to its end use and market destination. Classes 1 to 4 cover milk for use on the domestic market. Class 5 - the so-called "Special Class" - applies to milk intended for export as well as milk for use in products which face import competition in the domestic market. Class 5 is further subdivided into five sub-classes. Classes 5(d) and (e) apply exclusively to milk for use in exported products. Class 5(d) consists of the so-called "traditional planned exports". Class 5(e) covers milk that is to be exported for surplus removal purposes. ³⁷²

7.2 Both complainants focus on Classes 5(d) and (e) of the Special Milk Classes Scheme. ³⁷³ They consider that these Classes in the context of Canada's supply and price management system constitute:

The complainants conclude that under both alternatives the scheme results in export subsidies granted contrary to the Agreement on Agriculture (in particular, Article 3.3, Article 8 and/or Article 10.1 thereof).

7.3 The United States further claims that, to the extent that the scheme is an export subsidy contrary to the Agreement on Agriculture, it also violates Article 3 of the Agreement on Subsidies and Countervailing Measures ("SCM Agreement") which prohibits export subsidies.

7.4 The dairy products in question are: butter, cheese and "other milk products". The relevant marketing years are: 1995/1996 and 1996/1997. ³⁷⁴ Both complainants also refer to marketing year 1997/1998 which ended on 31 July 1998 and for which data only became available - and was submitted to us - after our first substantive meeting. However, in doing so neither of the complainants explicitly incorporated this marketing year under its claims. Since, moreover, marketing year 1997/1998 only ended some four months after the establishment of this Panel (on 25 March 1998), we are not called upon to make findings in respect of that marketing year. ³⁷⁵

7.5 In response Canada argues that the Special Milk Classes Scheme does not constitute an export subsidy either:

Canada submits that since the exports subject to this scheme are, therefore, not generated by export subsidies, they do not have to be counted against its scheduled reduction commitments, nor can they constitute a circumvention of these commitments in the sense of Article 10.1. Canada concludes, therefore, that the Special Milk Classes Scheme fully conforms to both the Agreement on Agriculture and to the SCM Agreement.

2. The tariff-rate quota for fluid milk

7.6 The United States also claims that access to the tariff-rate quota for fluid milk - which Canada granted in the Uruguay Round negotiations - is being restricted contrary to Canada's obligations under Article II of GATT 1994 and Article 3 of the Agreement on Import Licensing Procedures. The restrictions referred to are as follows: (i) entries are only allowed for consumer packaged milk for personal use by Canadians; and (ii) entries are limited to those valued at less than C$20.

7.7 To this claim, Canada responds that in its Schedule it limited access to the tariff-rate quota to cross border imports of consumer packaged milk by Canadians for personal use. Canada claims that this is clear from the "terms and conditions" attached to this concession in its Schedule, as well as from the negotiating history that led to this concession.

3. Other claims raised in the requests for this Panel

7.8 We note that the requests by the United States and New Zealand for the establishment of this Panel also alleged violations of Articles X, XI and XIII of GATT 1994. However, neither the United States nor New Zealand further pursued any of these claims during the Panel proceedings.

B. The Special Milk Classes scheme

1. Summary of claims and arguments of the parties

(a) New Zealand and the United States

7.9 New Zealand and the United States claim that under Classes 5(d) and (e), processors of dairy products for export are given access to milk at prices lower than those applying to milk for the manufacture of the same products for domestic consumption. In their view, this is done in order to remove surpluses of milk in a way that allows Canadian processors/exporters of dairy products to compete in export markets.

7.10 With respect to milk produced within the limits of the allocated producer quotas ("in-quota milk"), the Complainants argue that making milk available for use in exports at lower prices - under either Class 5(d) or (e) - can only be sustained because of the government's involvement, in particular the governmentally-imposed pooling of the relatively low returns from these exports with the higher returns obtained from milk sold for use on the domestic market. On these grounds, New Zealand and the United States submit that Classes 5(d) and (e) constitute an export subsidy whereby, as a result of extensive governmental involvement, producers are required to share the cost of selling milk at lower prices for export use and processors/exporters benefit from the cheaper milk made available to them to be competitive on export markets. In their view, the mechanism stimulates the removal of milk surpluses by way of exports.

7.11 In response to questions put to them by the Panel, the complainants clarified that their claims also cover exports generated under Class 5(e) from milk produced in excess of the allocated producer quotas ("over-quota milk"). This milk, as well, is sold for export at a lower price than the domestic milk price. However, as opposed to in-quota milk sold for export, the relatively low revenues from over-quota milk for export are generally not pooled with the higher revenues from milk used domestically. Nevertheless, for the complainants, the extent of federal and provincial governmental involvement in the arrangements under which milk is made available for export at lower prices - irrespective of whether the returns are pooled - suffices to conclude that the dairy products produced with over-quota milk are being exported with the help of export subsidies. According to the complainants, it is irrelevant for the processor producing for export - who can buy the milk at a cheaper price - whether the milk was produced in- or over-quota. The complainants submit that the competitive benefit thereby granted to processors/exporters could not exist without the governmentally established and enforced Special Milk Classes Scheme and that this benefit thus constitutes an export subsidy.

(b) Canada

7.12 Canada argues that the Special Milk Classes Scheme is producer driven and not directed by the government. Canada submits that milk producers producing for export follow commercial considerations and react to world market signals, not to government directions. According to Canada, the government does play a role in the scheme but one that is limited and essentially responsive to the initiatives of the industry. For Canada, the government only has an oversight function to protect the public interest.

7.13 With respect to in-quota milk sold for export, Canada argues that producers are free to collectively determine whether and to what extent they wish to provide in-quota milk for export purposes. According to Canada, the lack of government control, direction or coercion in exporting milk at a lower price is even more apparent with respect to over-quota milk. Canada submits that any qualified dairy producer in Canada is free to produce as much milk as it chooses. Milk produced over-quota is sold for export at a price based on actual world prices. According to Canada, that is also the price the producer receives since the returns from over-quota milk are not pooled with higher domestic milk returns.

7.14 Canada further argues that under the Agreement on Agriculture it was required to replace earlier quantitative restrictions on imports of milk with tariffs. Under the former quantitative restrictions regime, Canada had an obligation to also impose domestic restrictions on the production of milk (in accordance with Article XI:2(c)(1) of GATT). Under the new regime, no such domestic restrictions are required. As a result, Canada was free to produce more, including milk for export. According to Canada, the fact that it imposes tariffs leads to higher domestic prices. For exports, however, lower prices have to prevail in order to compete on world markets. A system of sales at differing prices for domestic and export markets is the consequence. Upholding the complainants' claims would, according to Canada, mean that any such two-tiered system would constitute an export subsidy. This would, according to Canada, in effect mean that a Member imposing tariffs on imports of a product (e.g., milk) can no longer export that product (e.g., milk domestically produced) without being considered to be granting export subsidies.

2. The Panel's decision of 16 December 1998

7.15 We submitted three sets of questions to the parties. The first set was submitted subsequent to our first substantive meeting; the second set after our second substantive meeting; and the third set after receipt of the answers to the second round of questions. We gave ample opportunity to each of the parties to comment on each others' answers.

7.16 After receipt of the US answers to our second set of questions, Canada raised an objection. In a letter dated 8 December 1998, Canada requested us to disregard US Exhibits 56 and 57 - containing data comparing milk prices under Classes 5(d) and (e) to milk equivalent prices under the Import for Re-Export Program (Exhibit 56) and to so-called international prices for milk, butter and skim milk powder (Exhibit 57) - which had been submitted by the United States together with its answers to the second round of Panel questions (in particular, Panel Questions 13 and 14 to the complainants ³⁷⁶ ). Canada made this objection on three grounds. First, Canada argued, these Exhibits contain substantial new factual information that is not required to respond to the Panel's questions. Second, according to Canada, the Exhibits are not relevant to the Panel questions at hand. Third, Canada submitted, the figures have been developed using a highly suspect and very opaque methodology that resulted in some glaring inaccuracies in the numbers. In response, the United States, in a communication dated 14 December 1998, noted that its Exhibits 56 and 57 are directly responsive to the Panel's questions and that, even if the methodology used in these Exhibits were to be flawed, this would not be a basis to disregard the data; at most, the weight to be given to this evidence could be affected.

7.17 Paragraph 7 of our Working Procedures provides as follows:

In a letter sent to the parties on 16 December 1998 the Panel decided the following:

(a) The Agreement on Agriculture and the SCM Agreement

7.18 Both complainants invoke the Agreement on Agriculture. Article 2 of this agreement provides that it applies to the agricultural products listed in Annex I. The "agricultural products" set out in Annex I include the products at issue in this dispute (butter, cheese and "other milk products"), all of which fall under HS Chapter 4. We thus find that the Agreement on Agriculture applies to the issue at hand.

7.19 The United States also invokes Article 3 of the SCM Agreement, which contains, inter alia, a general prohibition on export subsidies. However, according to its own terms, Article 3 of the SCM Agreement is qualified in its application to agricultural export subsidies by the provisions of the Agreement on Agriculture. Article 3.1 provides as follows:

In this respect, Article 21 of the Agreement on Agriculture also provides that:

7.20 The general position under the Agreement on Agriculture is that a Member is permitted to use export subsidies but only within the limits of the budgetary outlay and quantity commitment levels, if any, that are specified in that Member's WTO Schedule. The use of agricultural export subsidies beyond such scheduled limits is in effect prohibited by Article 3.3, Article 8 and Article 10 of the Agreement on Agriculture.

7.21 The use of export subsidies beyond such scheduled limits is, in principle, also actionable under the prohibition in Article 3 of the SCM Agreement. However, by virtue of Article 13 (c) (i) of the Agreement on Agriculture, export subsidies that conform fully to Part V of the Agreement on Agriculture are exempt from actions based on Article 3 of the SCM Agreement for the duration of the "implementation period" (in casu, up to 31 December 2003).

7.22 Accordingly, our conclusion with respect to whether the Special Milk Classes Scheme constitutes an export subsidy within the meaning of the Agreement on Agriculture that fully conforms with Part V of that Agreement (which includes Articles 8 to 11 as well as, by reference, Article 3.3), may be dispositive of the US claim for breach of Article 3 of the SCM Agreement.

7.23 On these grounds ³⁷⁷ , the Panel will first examine the claims made under the Agreement on Agriculture. At the same time we note that the parties do not disagree that the SCM Agreement is important to the contextual interpretation of the provisions of the Agreement on Agriculture dealing with export subsidies. As stated by the Appellate Body in its report on Brazil - Measures Affecting Desiccated Coconut:

To continue with The Agreement on Agriculture

³⁷² See paras. 2.38 - 2.40.

³⁷³ New Zealand's claims only cover Classes 5(d) and (e). The United States, on the other hand, submits that subsidized exports are made under each of the Special Classes but - as it states in its answer to Panel Question 1 to the complainants - "places particular emphasis on the subsidized exports occurring as a result of the operation of Special Classes 5(d) and (e)". Below, the Panel also addresses Classes 5(a) to (c) which cover milk for domestic use as well as milk for export. See para. 7.41 and footnotes 453 and 496.

³⁷⁴ See Table 1 in para. 3.1 above. The US claims only cover marketing year 1996/1997 but this for all three products (US answer to Panel Question 2 to the complainants). The claims by New Zealand cover both marketing years 1995/1996 and 1996/1997 and this in both cases for all three products at issue, except that "other milk products" are not included for marketing year 1995/1996 (New Zealand answer to Panel Question 2 to the complainants).

³⁷⁵ Our terms of reference, set out in document WT/DS103/5 and WT/DS113/5, only mandate us to "examine, in the light of the relevant provisions of the covered agreements cited by the United States in document WT/DS103/4 and by New Zealand in document WT/DS113/4, the matters referred to the DSB respectively by the United States and New Zealand in these documents" (emphases added). These documents, the requests for this Panel, were submitted to the DSB and incorporated in our terms of reference on 25 March 1998. The matters referred to therein, and thereby subjected to our review, do not include within their scope marketing year 1997/1998.

³⁷⁶ Question 13 reads: "The Import for Re-Export Program - a) Does the reference to 'products', within brackets, in the last part of Paragraph (d) of the Illustrative List, include 'like or directly competitive products'? - b) Do you consider that skim or whole milk powder are 'like or directly competitive' with fluid industrial milk?". Question 14 reads: "Please comment on Question 18 to Canada below". Question 18 to Canada reads: "If sales of products under special class 5(e) are to be competitive in world markets, the price at which products derived from out of quota milk are made available to exporters will have to be below market prices, in order for the transactions to be commercially viable from the exporters' point of view. Is there a risk or threat of such prices for particular transactions being below world market prices? Please comment in detail on this matter taking into account your replies to question 17 above. New Zealand and the United States are also invited to comment on this matter".

³⁷⁷ See paras. 7.19-7.22.

³⁷⁸ Appellate Body Report on Brazil - Desiccated Coconut, op. cit., p. 14.