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WORLD TRADE
ORGANIZATION

WT/DS103/AB/RW2
WT/DS113/AB/RW2

20 December 2002

(02-7032)

Original: English

CANADA — MEASURES AFFECTING THE IMPORTATION OF MILK
AND THE EXPORTATION OF DAIRY PRODUCTS

SECOND RECOURSE TO ARTICLE 21.5 OF THE DSU
BY NEW ZEALAND AND THE UNITED STATES


AB-2002-6


Report of the Appellate Body




  1. Introduction

  2. Background

  3. Written Arguments of the Participants and the Third Participants
  1. Claims of Error by Canada - Appellant

  1. Article 10.3 of the Agreement on Agriculture -Rules of Evidence

  2. Article 9.1(c) of the Agreement on Agriculture -"Payments Financed by Virtue of Governmental Action"

(a) "Payments" 

(b) "Financed by Virtue of Governmental Action" 

  1. Article 10.1 of the Agreement on Agriculture-"Export Subsidies"
  1. Written Arguments of New Zealand - Appellee
  1. Article 10.3 of the Agreement on Agriculture-Rules of Evidence
     
  2. Article 9.1(c) of the Agreement on Agriculture-"Payments Financed by Virtue of Governmental Action"

(a) "Payments"

(b) "Financed by Virtue of Governmental Action" 

  1. Article 10.1 of the Agreement on Agriculture-"Export Subsidies" 
  1. Written Arguments of the United States - Appellee 
  1. Article 10.3 of the Agreement on Agriculture-Rules of Evidence
     
  2. Article 9.1(c) of the Agreement on Agriculture-"Payments Financed by Virtue of Governmental Action"

(a) "Payments" 

(b) "Financed by Virtue of Governmental Action" 

  1. Article 10.1 of the Agreement on Agriculture -"Export Subsidies"
  1.  Written Arguments of the Third Participants
  1. Argentina
     
  2.  European Communities
  1. Issues Raised in this Appeal
     
  2. Article 10.3 of the Agreement on Agriculture -Rules of Evidence
     
  3. Article 9.1(c) of the Agreement on Agriculture -"Payments Financed by Virtue of Governmental Action"
  1. "Payments"
  1. General Remarks on Article 9.1(c) of the Agreement on Agriculture
     
  2. Individual Producer's Costs of Production or Industry-wide Average
     
  3. Imputed Costs
     
  4. Selling Costs
     
  5. Assessment of Evidence
     
  6. Conclusion on "Payments" under Article 9.1(c)
  1. "Financed by Virtue of Governmental Action"
     
  2. Conclusion on Article 9.1(c) of the Agreement on Agriculture
  1. Article 10.1 of the Agreement on Agriculture-"Export Subsidies"
     
  2. Findings and Conclusions

 

TABLE OF CASES CITED IN THIS REPORT

Short Title Full Case Title and Citation

Canada - Dairy

Appellate Body Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WT/DS103/AB/R, WT/DS113/AB/R and Corr.1, adopted 27 October 1999, DSR 1999:V, 2057

Panel Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WT/DS103/R, WT/DS113/R, adopted 27 October 1999, as modified by the Appellate Body Report, WT/DS103/AB/R, WT/DS113/AB/R, DSR 1999:VI, 2097


Canada - Dairy (Article 21.5 - New Zealand and US)

Appellate Body Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products - Recourse to Article 21.5 of the DSU by New Zealand and the United States, WT/DS103/AB/RW, WT/DS113/AB/RW, adopted 18 December 2001

Panel Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products - Recourse to Article 21.5 of the DSU by New Zealand and the United States, WT/DS103/RW, WT/DS113/RW, adopted 18 December 2001, as reversed by the Appellate Body Report, WT/DS103/AB/RW, WT/DS113/AB/RW


Canada - Dairy (Article 21.5 - New Zealand and US II)

Panel Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products - Second Recourse to Article 21.5 of the DSU by New Zealand and the United States, WT/DS103/RW2, WT/DS113/RW2, 26 July 2002

EC - Hormones

Appellate Body Report, EC Measures Concerning Meat and Meat Products (Hormones), WT/DS26/AB/R, WT/DS48/AB/R, adopted 13 February 1998, DSR 1998:I, 135

US - FSC

Panel Report, United States - Tax Treatment for "Foreign Sales Corporations", WT/DS108/R, adopted 20 March 2000, as modified by the Appellate Body Report, WT/DS108/AB/R, DSR 2000:IV, 1677

US - Wool Shirts and Blouses

Appellate Body Report, United States - Measure Affecting Imports of Woven Wool Shirts and Blouses from India, WT/DS33/AB/R and Corr.1, adopted 23 May 1997, DSR 1997:I, 323

US - Wheat Gluten

Appellate Body Report, United States - Definitive Safeguard Measures on Imports of Wheat Gluten from the European Communities, WT/DS166/AB/R, adopted 19 January 2001


WORLD TRADE ORGANIZATION
APPELLATE BODY

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

Second Recourse to Article 21.5 of the DSU
by New Zealand and the United States

Canada, Appellant
New Zealand, Appellee
United States, Appellee
Argentina, Third Participant
Australia, Third Participant
European Communities, Third Participant
AB-2002-6

Present:

Baptista, Presiding Member
Sacerdoti, Member
Taniguchi, Member

I. Introduction

1. Canada appeals certain issues of law and legal interpretations in the Panel Report, Canada - Measures Affecting the Importation of Milk and the Exportation of Dairy Products - Second Recourse to Article 21.5 of the DSU by New Zealand and the United States (the "Panel Report").1 The Panel was established to consider a complaint by New Zealand and the United States that certain measures taken by Canada to comply with the recommendations and rulings of the Dispute Settlement Body (the "DSB") in Canada - Dairy2 are not consistent with Canada's obligations under the Agreement on Agriculture and the Agreement on Subsidies and Countervailing Measures (the "SCM Agreement ").

2. In Canada - Dairy, the original panel and the Appellate Body found, inter alia, that Canada provided, through Special Milk Classes 5(d) and 5(e), "export subsidies" within the meaning of Article 9.1(c) of the Agreement on Agriculture . The original panel and the Appellate Body also found that Canada provided these export subsidies in excess of the quantity commitment levels specified in its Schedule to the General Agreement on Tariffs and Trade 1994 (the "Schedule") and that, therefore, Canada had acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on Agriculture . On 27 October 1999, the DSB adopted the original panel and Appellate Body reports.

3. On 23 December 1999, pursuant to Article 21.3(b) of the Understanding on Rules and Procedures Governing the Settlement of Disputes (the "DSU"), Canada, New Zealand, and the United States agreed that the reasonable period of time for Canada to implement the recommendations and rulings of the DSB would expire on 31 December 2000.3 On 11 December 2000, the parties agreed to extend this period of time until 31 January 2001.4

4. Canada subsequently adopted certain measures with a view to implementing the recommendations and rulings of the DSB. These measures are described in Section II of this Report. Taking the view that certain of these measures were not consistent with Canada's obligations under the Agreement on Agriculture and the SCM Agreement , New Zealand and the United States requested, on 16 February 2001, that the matter be referred to a panel pursuant to Article 21.5 of the DSU.5

5. On the same day, New Zealand and the United States also requested authorization from the DSB to suspend concessions and other obligations, as provided for in Article 22.2 of the DSU.6 Canada objected to the level of suspension proposed and the matter was referred to arbitration, pursuant to Article 22.6 of the DSU.7 However, the parties agreed to request the arbitrator to suspend its work pending the outcome of the Article 21.5 proceedings.8

6. The panel in Canada - Dairy (Article 21.5 - New Zealand and US)9 found that Canada provided, through its "commercial export milk" ("CEM") mechanism, "export subsidies" within the meaning of Article 9.1(c) of the Agreement on Agriculture . The panel also found that Canada provided these export subsidies in excess of the quantity commitment levels specified in its Schedule and that, therefore, Canada had acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on Agriculture . The Appellate Body reversed the panel's findings on the grounds that the panel had erred in its interpretation of Article 9.1(c). The Appellate Body held that the appropriate standard, in those proceedings, for determining whether "payments" are made under Article 9.1(c), is not, as held by the first Article 21.5 panel, the domestic price, but rather the producer's costs of production. However, in the light of the factual findings made by the first Article 21.5 panel, the Appellate Body was unable to determine whether the implementation measures involved such "payments" and, hence, export subsidies within the meaning of Article 9.1(c). Consequently, the Appellate Body was also unable to determine whether these measures were consistent with Articles 3.3 and 8 of the Agreement on Agriculture.10

7. On 6 December 2001, before adoption of the panel and Appellate Body reports in the first Article 21.5 proceedings11, New Zealand and the United States requested the establishment of a second Article 21.5 panel. They maintained that the measures taken by Canada to comply with the recommendations and rulings of the DSB of 27 October 1999, that is, the same measures at issue in the first Article 21.5 proceedings, were inconsistent with Canada's obligations under the Agreement on Agriculture .12

8. On 18 December 2001, Canada, New Zealand, and the United States agreed that the arbitration previously requested by Canada under Article 22.6 of the DSU would remain suspended pending the outcome of the second Article 21.5 proceedings.13 The parties also agreed that New Zealand and the United States would request that the work of the Panel be suspended pursuant to Article 12.12 of the DSU until 18 February 2002.14

9. In the Panel Report, circulated to Members of the World Trade Organization (the "WTO") on 26 July 2002, the Panel concluded that:

… Canada, through the CEM scheme and the continued operation of Special Milk Class 5(d), has acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on Agriculture , by providing export subsidies within the meaning of Article 9.1(c) of the Agreement on Agriculture in excess of its quantity commitment levels specified in its Schedule for exports of cheese and "other dairy products". In light of our alternative finding … that Canada has acted inconsistently with its obligations under Article 10.1 of the Agreement on Agriculture, we conclude that Canada has acted inconsistently with its obligations under Article 8 of the Agreement on Agriculture.15

The Panel recommended that the DSB request Canada "to bring its dairy products marketing regime into conformity with its obligations in respect of export subsidies under the Agreement on Agriculture."16

10. On 23 September 2002, Canada notified the DSB of its intention to appeal certain issues of law covered in the Panel Report and certain legal interpretations developed by the Panel, pursuant to Article 16.4 of the DSU, and filed a Notice of Appeal pursuant to Rule 20 of the Working Procedures for Appellate Review (the "Working Procedures").17 On 3 October 2002, Canada filed its appellant's submission.18 On 18 October 2002, New Zealand and the United States each filed an appellee's submission.19 On the same day, Argentina and the European Communities each filed a third participant's submission.20 On the same day, Australia notified the Appellate Body Secretariat that, although it would not file a written submission, it intended to participate at the oral hearing.21

11. The oral hearing in the appeal was held on 31 October 2002. The participants and Argentina, Australia, and the European Communities presented oral arguments and responded to questions put to them by the Members of the Division hearing the appeal.

II. Background

12. The original panel found, inter alia , and the Appellate Body upheld, that Canada provided, through Special Milk Classes 5(d) and 5(e), "export subsidies" within the meaning of Article 9.1(c) of the Agreement on Agriculture . It was also found that these subsidies were being provided for quantities of exports that exceeded the quantity commitment level specified in Canada's Schedule. The original panel concluded, and the Appellate Body upheld, that Canada, therefore, had acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on Agriculture .22

13. By way of implementation, Canada abolished Special Milk Class 5(e) and restricted export subsidies under Special Milk Class 5(d) to its commitment levels.23 At the same time, Canada established a new class of milk, Class 4(m), under which over-quota milk can be sold as domestic animal feed. Canada otherwise left unchanged its domestic milk supply management system, under which domestic milk supply is controlled through the allocation of quota to individual milk producers by government agencies.24 Generally, a producer can sell milk domestically only within the limits of its quota. The only exception is that a producer can sell over-quota milk in the new Class 4(m) as domestic animal feed, but for a much lower price.25 Moreover, the price of domestic milk is fixed by government agencies. Government agencies also market domestic milk, collect the sales proceeds and distribute these proceeds among producers.26

14. Canada also introduced a new category of milk for export processing, known as "commercial export milk" ("CEM"). Sales of CEM are made by Canadian producers to Canadian processors, for processing of that milk into various dairy products for export. These sales are made pursuant to "pre-commitment" contracts, that is, contracts concluded in advance of milk production.27 Canadian producers may sell any quantity of CEM to processors on terms and conditions freely negotiated between the producer and the processor. Sales of CEM do not require a quota or any other form of permit from the Canadian government or its agencies. Revenues derived from sales of CEM are collected directly by producers, without government involvement. However, if a dairy product derived from CEM is sold on the domestic market, the processor is liable to financial penalties for diverting the dairy product into the domestic market. The factual aspects of the new scheme are set out in greater detail in the Panel Report.28

III. Written Arguments of the Participants and the Third Participants

A. Claims of Error by Canada - Appellant

1. Article 10.3 of the Agreement on Agriculture -Rules of Evidence

15. Canada argues that the Panel's interpretation of Article 10.3 is "plainly erroneous", as this provision sets out a "reverse" burden of proof that requires the responding Member to establish a rebuttable presumption that its measures are not inconsistent with its obligations. It then falls upon the complaining Members to present evidence and argument to rebut this presumption.

16. Canada contends that the Panel erroneously imposed a minimal burden on the complaining Members in examining whether they had made out a prima facie case. Canada also submits that it had presented sufficient evidence to raise a rebuttable presumption showing that there is no export subsidy and that the United States and New Zealand did not succeed in rebutting this presumption. Had it properly applied Article 10.3, the Panel would have ruled in favour of Canada.

2. Article 9.1(c) of the Agreement on Agriculture -"Payments Financed by Virtue of Governmental Action"

17. Canada claims that the Panel erred in finding that Canada's measures provide export subsidies within the meaning of Article 9.1(c) of the Agreement on Agriculture and disagrees with the Panel's findings both with respect to "payments" and to "financed by virtue of governmental action".

(a) "Payments"

18. With respect to "payments", Canada argues, first, that the Appellate Body intended the cost of production standard to be based on the costs of individual dairy farmers and not on a single, industry-wide average cost of production figure. Canada points to statements of the Appellate Body such as "each producer decid[ing] for itself ", "value of the milk to the producer", and "cost incurred by the producer" as demonstrating that the Appellate Body focused on the costs of production of the individual milk producer. An industry-wide average, in Canada's view, does not have "any relevance" to the decisions of individual producers participating in CEM transactions.

19. Second, Canada argues that the Panel erred by including imputed returns for family labour, return to management, and return to equity in a cost of production determination. Imputed returns constitute government intervention in the marketplace and are included in the Canadian Dairy Commission (the "CDC") annual cost of production survey to ensure that dairy farmers obtain "a fair return for their labour and investment".29 Further, returns to family labour, management, and owner's equity are derived from the profits of the dairy enterprise. Canada asserts that profits are distinct from costs and are, therefore, excluded from the cost of production determination.

20. Third, Canada maintains that marketing, transport, and administrative costs are not production costs and, therefore, should not be included in the cost of production determination. Canada also disagrees with the Panel's finding that the costs of acquiring quota should be included in the cost of production determination. Quota costs should be treated as marketing costs confined to the domestic market and not as relevant in examining export sales. Moreover, Canada considers that quota is an intangible asset with an indefinite useful life and therefore disagrees with the Panel's conclusion that Generally Accepted Accounting Principles ("GAAP") permit amortization of quota costs.

21. Finally, Canada disputes the nature of evidence which the Panel, in Canada's view, required in order to show that "payments" are not being made. According to Canada, the Panel held that there would be no "payments" if Canada could establish that the individual producer's costs of production allow the producer to participate in the CEM market without incurring losses. Canada argues that the Panel, in so holding, required Canada to match the costs of individual producers participating in CEM transactions with the returns obtained by those same producers. This would place on Canada a burden that it "cannot possibly be expected to meet".30 Canada alleges that Article 9.1(c) cannot contemplate the existence of "payments" where a Member demonstrates that a significant proportion of producers have costs of production allowing them to participate in CEM transactions, while recouping their total cost of production.

(b) "Financed by Virtue of Governmental Action"

22. Canada submits that the Panel erred by finding a "demonstrable link" between the financing of "payments" on the sale of CEM and Canadian "governmental action". Canada believes that for a demonstrable link to exist between these two elements, there must be affirmative governmental action over the decisions of producers, for instance, where the government provides, raises, furnishes, or manages funds. Canada alleges that, where, as in the present case, government does no more than establish a framework merely enabling producers and processors, if they so choose, to freely negotiate the purchase and sale of milk for export, payments are not "financed by virtue of governmental action". Canada argues that, as the Appellate Body said, the Canadian government does not oblige or drive producers to produce and sell CEM.31

23. In Canada's view, exempting processors of CEM from any requirement to pay the domestic administered price and the prohibition of diversion of CEM into the domestic market are not demonstrably linked to the financing of any payments and are in no way inconsistent with Canada's obligations under the covered agreements. Similarly, Canada contends that the practice of pre-committing sales of CEM does not "finance" payments, but rather ensures that CEM is not surplus milk.

24. Next, according to Canada, the Panel's reliance upon the notion of "cross-subsidization" introduces a "foreign" and "open-ended notion" into Article 9.1(c) without this discipline having been negotiated and accepted by WTO Members.32 The domestic regulated price does not finance "payments" within the meaning of Article 9.1(c) because it is linked only to the domestic market. Canada further alleges that it makes no sense that a producer would willingly produce additional milk and sell it at a loss. Canada also contends that a finding of "cross-subsidization" cannot, in any case, extend to the approximately 100 CEM producers in Canada that do not sell milk in the domestic market.

3. Article 10.1 of the Agreement on Agriculture -"Export Subsidies"

25. Canada submits that, if the Panel had correctly interpreted item (d) of the Illustrative List of Export Subsidies (the "Illustrative List") in Annex I of the SCM Agreement in the light of the context provided by Article 1.1(a)(1)(iv) of that Agreement, it could only have concluded that CEM is not provided "indirectly through government-mandated schemes". The Panel also erred in rejecting the evidence presented by Canada, showing that CEM is available on terms as favourable as those applicable to milk components under Canada's Import for Re-Export Program ("IREP"). Therefore, in Canada's view, CEM sales do not constitute export subsidies within the meaning of Article 10.1 of the Agreement on Agriculture.

B. Written Arguments of New Zealand - Appellee

1. Article 10.3 of the Agreement on Agriculture -Rules of Evidence

26. New Zealand argues that, if the Panel did not apply the burden of proof rules as set forth in Article 10.3, this was to Canada's advantage, because Canada was relieved from a burden it would otherwise have borne. Furthermore, the Panel's analysis "makes clear" that the Panel did require Canada to establish that no export subsidy existed and that Canada failed to discharge that burden. New Zealand submits that, in any event, any error made by the Panel in interpreting Article 10.3 had no impact on the outcome of the case.

2. Article 9.1(c) of the Agreement on Agriculture -"Payments Financed by Virtue of Governmental Action"

(a) "Payments"

27. New Zealand contends that Canada's objections to the Panel's application of the average total cost of production standard are founded on a rejection of this standard's inherent logic. Canada's approach would make the standard "fundamentally unworkable" and would "void it of any content".33

28. New Zealand submits, first, that a determination whether producers make sales of CEM at prices below the average total cost of production can be made only by looking at an average industry-wide determination of the total cost of production. According to New Zealand, a determination of the average total cost of production on the basis of individual producer costs of production, as proposed by Canada, is "simply unworkable"34 and implies that the average total cost of production of each and every Canadian producer would have to be considered in order to determine whether any "payments" have been made.

29. Second, New Zealand argues that imputed costs of family labour, return to management, and return to equity must be included in the cost of production determination, because these costs represent costs incurred by the producer. New Zealand considers that these imputed costs are distinct from profits, as profits are "something over and above" all fixed and variable costs.35 New Zealand also believes that the Panel was correct to rely on CDC cost of production data, as these are based on an objective study and are subject to audit.

30. Third, New Zealand submits that Canada's complaint about the Panel's treatment of transport and marketing costs, as well as of quota costs, is also without merit. All these costs, according to New Zealand, are costs incurred by the producers that must be recouped in the sales price. Describing costs as "marketing" costs, rather than "production" costs, does not alter this fact. New Zealand also argues that the cost of quota cannot be eliminated by assigning it to the domestic market, because the Appellate Body has said that costs related to both the domestic and the export markets have to be taken into consideration.

(b) "Financed by Virtue of Governmental Action"

31. New Zealand opines that the essence of Canada's objections to the Panel's conclusions on the phrase "financed by virtue of governmental action" is that the relevant governmental action does not "oblige" or "drive" producers to "produce and sell" CEM. However, in New Zealand's view, the Appellate Body did not find that "payments" can only be "financed by virtue of governmental action" where producers are "obliged" or "driven" to produce and sell CEM. Rather, the Panel correctly examined whether there was a demonstrable link between the governmental action and the financing of "payments".

32. In New Zealand's view, exempting the processor from the requirement to pay the higher domestic price is clearly linked to the financing of "payments". The sole purpose of the exemption is to make milk available for export processing. This would not be possible if processors had to purchase milk at the domestic price.

33. With respect to the Canadian argument that the notion of "cross-subsidization" is "foreign" to the Agreement on Agriculture and any other covered agreement, New Zealand claims that cross-subsidization is relevant under the Agreement on Implementation of Article VI of the General Agreement on Tariffs and Trade 1994 (the "Anti-Dumping Agreement "). Also, the possibility of cross-subsidization under Article 9.1(c) was identified, as a relevant consideration, by the Appellate Body in the first Article 21.5 proceedings.

3. Article 10.1 of the Agreement on Agriculture -"Export Subsidies"

34. In New Zealand's view, Canada's arguments that the Panel should have derived guidance from Article 1 of the SCM Agreement in its interpretation of item (d) of the Illustrative List of the SCM Agreement would artificially narrow the scope of item (d). The Panel, in New Zealand's view, applied item (d) in accordance with its terms, and it was unnecessary to look elsewhere to restrict or expand the scope of that provision. New Zealand also agrees with the Panel that IREP imports are available to export processors on commercially less favourable terms than CEM.

C. Written Arguments of the United States - Appellee

1. Article 10.3 of the Agreement on Agriculture -Rules of Evidence

35. The United States argues that Canada's objection to the Panel's interpretation of Article 10.3 overlooks the fact that the Panel's approach could only serve to benefit Canada, since the Panel unnecessarily examined initially whether the complainants had made out a prima facie case. However, the United States is of the view that this additional step did not change the outcome of the dispute.

2. Article 9.1(c) of the Agreement on Agriculture -"Payments Financed by Virtue of Governmental Action"

(a) "Payments"

36. The United States opines that the Panel properly concluded that Canadian milk producers are making "payments" to Canadian milk processors. First, the United States submits that the Panel correctly found that the Appellate Body, in the first Article 21.5 proceedings, did not intend an individual cost of production standard and that a cost of production benchmark based on individual producers was "unworkable".36

37. Second, the United States agrees with the Panel that all economic costs should be included in the cost of production benchmark. With respect to imputed costs, the Panel correctly recognized that investment of family labour, management, and capital in the dairy enterprise involves economic opportunity costs. The fact that the CDC calculates these costs annually and includes them in its survey of costs of production contradicts Canada's argument that a determination of a proper amount for imputed returns to family labour, management, and owner's equity is inherently speculative as well as subjective. The United States asserts that the use of this data to establish the domestic regulated price does not detract from the validity of this data.

38. Third, the United States also agrees with the Panel that marketing, transportation, and administrative costs are to be included in the cost of production standard, as they represent real costs that a producer must recoup in order to remain in business over time. Similarly, the cost of obtaining a production quota represents a real cost that a producer will incur in the production of milk, regardless of its treatment under accounting principles.

39. Finally, the United States submits that the Panel correctly found that Canada's individual producer data does not establish that producers are not making "payments" to processors. Canada was unable to provide evidence correlating individual producer's costs of production with sales by each producer in the CEM market, and the Panel correctly declined to assume that only those producers with costs of production below the CEM price participate in the CEM market.

(b) "Financed by Virtue of Governmental Action"

40. The United States argues that Canada's objections to the Panel's findings with respect to the phrase "financed by virtue of governmental action" are without merit. The United States disagrees with Canada's apparent contention that the Appellate Body has already ruled on the governmental action element of Article 9.1(c). The Appellate Body did not find that Article 9.1(c) requires that producers be "obliged" or "driven" to produce additional milk for export.

41. In the United States' view, the Appellate Body explained, in the first Article 21.5 proceedings, that relevant governmental action could include the regulation of the supply and price of milk in the domestic market. The Panel then rightly concluded that a profit-maximizing milk producer will consider the extent to which the cost-covering, regulated price of domestic milk allows it to make additional sales in the CEM market while still covering its marginal costs. Canada is incorrect in its assertion that the Panel found that Canadian governmental action merely makes it possible for producers to make "payments".

42. The United States agrees that Canada's policies of exempting the processor from paying the higher domestic price, and of prohibiting diversion of CEM into the domestic market support the Panel's finding that payments are "financed by virtue of governmental action". Through these policies, Canadian governmental action ensures that the bulk of non-quota milk will be channelled into the CEM market.

43. The United States also agrees with the Panel that the requirement to pre-commit CEM sales creates an additional incentive to dedicate a larger quantity of milk to the CEM market than would otherwise be the case. As a result, the pre-commitment policy supports the Panel's finding of a "demonstrable link" between governmental action and the financing of "payments".

44. Finally, the United States believes that Canada mischaracterizes the Panel's analysis of Canada's regulation of the domestic supply and price of milk. The Panel did not create any new form of subsidization or new WTO obligation; rather, the Panel "carefully" followed the Appellate Body's guidance in this regard and used the term "cross-subsidization" as a convenient shorthand expression in its analysis of the governmental action in the form of the regulation of the domestic price and supply of milk.37 The United States asserts that the Panel carefully considered whether the domestic regulated price allowed producers to engage in less remunerative CEM sales, while at least covering their marginal costs of production.

3. Article 10.1 of the Agreement on Agriculture -"Export Subsidies"

45. According to the United States, the Panel correctly found that Canada's CEM scheme is inconsistent with Article 10.1 of the Agreement on Agriculture . Contrary to Canada's allegations, the Panel did not overlook relevant context in applying item (d) of the Illustrative List of the SCM Agreement . Furthermore, the United States agrees with the Panel that Canadian milk processors obtain CEM at more favourable terms than whole milk powder through IREP.

D. Written Arguments of the Third Participants

1. Argentina

46. Argentina agrees broadly with the Panel's reasoning under Article 9.1(c) and considers that, given the characteristics of the Canadian milk supply system-as discussed by the Panel-,Canadian producers will channel their surplus production into the CEM market. Argentina also submits that the use of the phrase "by virtue of ", rather than of the word "by", indicates that Article 9.1(c) covers circumstances where "payments" are not financed directly by government, and where government does not intervene directly in the provision of "payments", but nevertheless creates "a whole set of circumstances" that ultimately lead to "payments" on exports.38

47. As regards Article 10.1 of the Agreement on Agriculture , Argentina concurs with the Panel that Canada failed to establish the absence of the three elements of export subsidies contemplated by item (d) of the Illustrative List of the SCM Agreement. A governmental measure that falls under item (d) of the Illustrative List of the SCM Agreement is, at the same time, an "export subsidy" within the meaning of Article 10.1, even if no charge on the public account is involved.

2. European Communities

48. The European Communities agrees with Canada that the Panel incorrectly interpreted Article 10.3 of the Agreement on Agriculture . The correct standard of proof to be applied in this case is that Canada should make out a prima facie case to establish that its measure does not constitute an "export subsidy".

49. With respect to the issue of "payments" under Article 9.1(c) of the Agreement on Agriculture , the European Communities considers that the average total cost of production is not the appropriate benchmark for assessing whether there are "payments" within the meaning of Article 9.1(c). The Panel's standard makes it possible to find a subsidy where no "benefit" is provided and, in any event, the standard is "unworkable".39 The Panel also erred in including in the cost of production standard an amount for profit as well as cost items such as family labour, return on management, and return on equity. Finally, in examining the evidence of "payments", the Panel imposed an insurmountable burden of proof on Canada.

50. With respect to the phrase "financed by virtue of governmental action", the European Communities "fully supports" Canada's appeal.40 The Panel applied a standard that contradicts the Appellate Body's guidance in that the Panel found that it was sufficient to show that governmental action makes sales possible. None of the four governmental actions identified by the Panel-that is, prohibition on diversion of CEM into the domestic market; the exemption of export processors from paying the fixed domestic price; cross-subsidization; and the pre-commitment requirement-is sufficient to establish that producers are obliged or driven to provide CEM.

51. The European Communities opines that the Panel added to the obligations under Article 9.1(c) of the Agreement on Agriculture . An interpretation of the term "financed" as also covering payments-in-kind goes beyond the ordinary meaning of the term. Article 9.1(c) includes private party payments only to the extent that "payments" are financed from the proceeds of a levy imposed on the agricultural product concerned. Accordingly, the European Communities submits that, for a measure to fall under Article 9.1(c), the government must "impose" or "mandate" payments.41

52. The European Communities further contends that the Panel's findings are based on the assumption that WTO Members intended to prevent cross-subsidization, that is, that WTO Members intended to target the omission of governments to prevent the "natural economic behaviour" of cross-subsidization.42 However, Article 9.1(c), like all WTO law, is concerned only with governmental actions, not also with governmental omissions.

53. The European Communities disagrees with the Panel's findings on Article 10.1 of the Agreement on Agriculture . The notion of an export subsidy under this provision must be read "co-extensively"43 with the basic definition of subsidies under the SCM Agreement , unless the Agreement on Agriculture contains an explicit derogation. In the European Communities' view, the measure at issue does not meet the basic definitional elements for a "financial contribution", under Article 1.1(a)(1)(iv) of the SCM Agreement , because it does not "entrust or direct a private body to carry out" a function otherwise carried out by governments. Nor is the measure a "government-mandated scheme" within the meaning of item (d) of the Illustrative List of the SCM Agreement .


To continue with IV. Issues Raised in this Appeal


1 WT/DS103/RW2, WT/DS113/RW2, 26 July 2002. In this Report, we refer to the panel that considered the second recourse to Article 21.5 of the DSU by New Zealand and the United States-and whose findings are the subject of this appeal-as the "Panel".

2 The recommendations and rulings of the DSB resulted from the adoption, by the DSB, of the panel report in Canada - Dairy. In this Report, we refer to the panel that considered the original complaint brought by New Zealand and the United States as the "original panel".

3 WT/DS103/10, WT/DS113/10, 7 January 2000.

4 WT/DS103/13, WT/DS113/13, 13 December 2000.

5 WT/DS103/16, 19 February 2001; WT/DS113/16, 19 February 2001.

6 WT/DS103/17, 19 February 2001; WT/DS113/17, 19 February 2001.

7 WT/DS103/18, 28 February 2001; WT/DS113/18, 28 February 2001.

8 WT/DS103/14, 5 January 2001, para. 9; WT/DS113/14, 5 January 2001, para. 9.

9 In this Report, we refer to this panel as the "first Article 21.5 panel".

10 Appellate Body Report, Canada - Dairy (Article 21.5 - New Zealand and US), paras. 126-127.

11 The DSB adopted the panel report and the Appellate Body Report in Canada - Dairy (Article 21.5 -New Zealand and US) on 18 December 2001.

12 WT/DS103/23, 6 December 2001; WT/DS113/23, 6 December 2001.

13 WT/DS103/24, 2 January 2002; WT/DS113/24, 2 January 2002.

14 Ibid. This request, however, did not extend to matters relating to panel composition.

15 Panel Report, para. 6.1.

16 Panel Report, para. 6.3.

17 Canada appeals the Panel's findings under Articles 3.3, 8, 9.1(c), 10.1, and 10.3 of the Agreement on Agriculture .

18 Pursuant to Rule 21 of the Working Procedures.

19 Pursuant to Rules 22 and 23(3) of the Working Procedures.

20 Pursuant to Rule 24(1) of the Working Procedures.

21 Pursuant to Rule 24(2) of the Working Procedures.

22 Panel Report, Canada - Dairy, para. 8.1(a); Appellate Body Report, Canada - Dairy, para. 144(b).

23 Canada's quantity commitment levels, as contained in Part IV, Section II, of its Schedule, are: 3,500 tonnes for butter; 44,953 tonnes for skim milk powder; 9,076 tonnes for cheese; and 30,282 tonnes for other milk products.

24 In response to questioning at the oral hearing, Canada stated that, when the milk supply management system was created, quota was allocated among existing farmers. Canada also indicated that quota is a transferable right and that an active market for quota has developed. The price of quota on this market is currently in the range of C$15,000-C$30,000/kg of butterfat per day.

25 The administered price for Class 4(m) milk is C$10 per hectolitre ("hl"), as opposed to C$49.48/hl and C$56.06/hl, which is the price range for domestic industrial milk. Canada does not dispute these figures. (Panel Report, footnote 410 to para. 5.116)

26 For a more detailed description of the pre-existing milk supply management system see Appellate Body Report, Canada - Dairy, paras. 6-16; and Panel Report, Canada - Dairy, paras. 2.1-2.66.

27 At the oral hearing, Canada informed the Appellate Body that, generally, producers pre-commit to sell CEM at least 30 days in advance of the sale.

28 Panel Report, paras. 2.2-2.4. See also Panel Report, Canada - Dairy (Article 21.5 - New Zealand
and US)
, paras. 3.1-3.9. The average CEM price is approximately C$29/hl. (Panel Report, para. 5.60)

29 See Section 8 of the Canadian Dairy Commission Act (R.S.C. 1985, c. C-15), Exhibit CDA-3 submitted by Canada to the Panel; Exhibit NZ-8 submitted by New Zealand to the Panel.

30 Canada's appellant's submission, para. 47.

31 Appellate Body Report, Canada - Dairy (Article 21.5 - New Zealand and US), para. 117.

32 Canada's appellant's submission, para. 91.

33 New Zealand's appellee's submission, paras. 3.08 and 3.17.

34 Ibid., para. 3.35.

35 Ibid., para. 3.23.

36 United States' appellee's submission, para. 29.

37 United States' appellee's submission, para. 61.

38 Argentina's third participant's submission, para. 26.

39 European Communities' third participant's submission, title of section IV.A.1 (b), p. 12.

40 Ibid., para. 67.

41 Ibid., title of section IV.B.4 (b), p. 25.

42 European Communities' third participant's submission, para. 115.

43 Ibid., para. 125.