12 August 1994

11. All tobacco sold in the United States, whether domestic or imported, was subject to inspection in the United States. ¹¹ By statute, domestic tobacco was inspected at the warehouse for grade and quality, and required inspection of each individual lot. Imported tobacco was inspected for grade and quality at the point of entry into the United States and before it entered domestic commerce. The inspection of imported tobacco took place on the basis of samples. By statute, importer fees and charges for inspection "shall, as nearly as practicable, cover the costs of such services, including the administrative and supervisory costs customarily included by the Secretary in user fee calculations". ¹² Section 1106(c) of the 1993 Budget Act amended this cost of services requirement by adding a requirement that inspection fees for imported tobacco "be comparable to the fees and charges fixed and collected for services provided in connection with tobacco produced in the United States".

General

12. Argentina, Brazil, Canada, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe requested the Panel to find that provisions of the 1993 Budget Act, specifically the DMA (Section 1106(a)), the BDA (Section 1106(b)(1)), the NNCA (Section 1106(b)(2)) as well as the fees for inspecting imported tobacco (Section 1106(c)), were not consistent with U.S. obligations under Articles III:5, III:2 and VIII:1 of the General Agreement. Argentina, Brazil, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe also requested the Panel to find that the provisions of Section 1106(a) of the 1993 Budget Act were inconsistent with Article III:4 of the General Agreement. The complainants submitted that the above-mentioned provisions nullified or impaired benefits accruing to them under the General Agreement. Accordingly, the complainants requested that the Panel recommend that the United States bring its laws into conformity with its obligations under the General Agreement.

13. The United States, submitting that the burden was on the complainants in this dispute to establish that there was inconsistency between the U.S. measures in dispute and the General Agreement, was of the view that the complainants had not met that burden. Further, the United States considered that the BDA and the NNCA were border tax adjustments and therefore consistent with Article III, that the price support programme was covered by Article III:8(b), and that the inspection fee provision did not require administrative action inconsistent with Article VIII of the General Agreement. Accordingly, the United States requested the Panel to find that the measures were consistent with the General Agreement.

Domestic Marketing Assessment (Section 1106(a))

14. Argentina, Brazil, Canada, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe submitted that the U.S. domestic tobacco content requirements of Section 1106(a) (the DMA ¹³ ) of the 1993 Budget Act conflicted with paragraph 5 of Article III of the General Agreement. The United States had established and maintained an internal regulation (i.e. the DMA) that was imposed on domestic manufacturers of cigarettes within the United States. The DMA contained a "quantitative" regulation requiring that domestic manufacturers certify that they used in the manufacture of cigarettes at least 75 per cent domestic tobacco on an annual basis. Failure to comply with this condition subjected the manufacturer to pecuniary penalties and the requirement to buy additional domestic tobacco. This provision was thus related to "the mixture, processing or use" of tobacco so as to require "directly or indirectly", that a "specified amount or proportion" of tobacco "be supplied from domestic sources". ¹⁴ The complainants submitted that at least one GATT panel had interpreted the provisions of Article III:5 to apply to provisions that specifically required the "mixture, processing or use" of a product "in specified amounts or proportions". ¹⁵ Section 1106(a) of the Budget Act was such a provision. By imposing strict financial penalties on companies that failed to meet these requirements, the DMA effectively prohibited domestic manufacturers from using more than 25 per cent imported tobacco on an annual basis in the manufacture of cigarettes. The complainants referred to the U.S. arguments in the Animal Feed panel in which the U.S. representative had stated that "Article III:5 prohibits regulations which require, directly or indirectly, that any specified amount or proportion of a domestic product be mixed, processed or used". ¹⁶ Following the logic of the United States in that case, its current law restricting the use of imported tobacco in cigarettes was inconsistent with Article III:5. In addition to the above, in the proposed rules to implement the DMA, this statutory provision was referred to as a "domestic content requirement" no less than 13 times, including in a definition of the 75/25 ratio. In the same proposed rules, the DMA was specifically referred to as the "domestic content marketing assessment". Finally, an analysis by the USDA referred to the DMA as providing "for a minimum domestic content".

15. The United States considered that the burden of establishing an inconsistency with the General Agreement rested on the complainants, noting that the DMA provisions did not require that a product sold in the United States contain any particular mix of tobacco. Nor did the DMA limit imports of products. According to the United States, its price support programme created a high price, artificially, for domestic tobacco. This high, government-mandated, support price for domestic tobacco (well above world market prices) permitted importers to gain very significant net profits while still underselling U.S. tobacco. The United States submitted that the DMA provisions were essentially an effort to adjust the cost of the domestic price support programme for tobacco. Elimination of the programme would result in lower prices and greater production. Larger, but fewer, producing units with attendant economies of scale would result. Marketing costs would be lower. All variable and fixed input costs except labour - chemicals, seedlings, fertilizers, energy, machinery and interest - were already as low or lower than costs among the most efficient foreign competitors. Land costs would decline with removal of quota rent. Other economic factors - transportation efficiencies, relative proximity to major consuming markets and growing conditions conducive to producing quality leaf - would enhance demand for U.S. cigarette tobacco in the domestic and export markets. Ultimately, a more market-driven programme would be likely to reduce incentives for most imported tobacco to be sold in the United States. The abrogation of the programme would also probably increase the competitiveness of U.S. tobacco in its own market. In the end, this would greatly reduce the share of competing trade in the market.

16. Argentina, Brazil, Canada, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe submitted that the U.S. assertion that the DMA did not require that a product in the United States contain any particular mix of tobacco was not an accurate or reasonable interpretation of Section 1106(a) of the Budget Act. Section 1106(a) directly required the use of U.S. produced tobacco. The statute stated that a domestic manufacturer of cigarettes had to certify the percentage of tobacco used by the manufacturer to produce cigarettes. Heavy penalties were imposed on domestic manufacturers of cigarettes that failed to use at least 75 per cent U.S. grown tobacco. In any event, the DMA indirectly required the use of domestic products in certain specified amounts or proportions through the imposition of assessments and mandatory purchase requirements. This was contrary to Article III:5, which provided that a contracting party could not establish any internal quantitative regulation which required, "directly or indirectly", that any specified amount or proportion of any product be supplied from domestic sources. The complainants did not dispute that the United States had the right to promote rural economies, but as a contracting party to the GATT, the United States had to pursue these goals in a manner that did not violate its obligations under the General Agreement. This principle was made clear in the 1958 panel decision on Italian Discrimination Against Imported Machinery, ¹⁷ a principle recognized by the United States in the arguments it advanced in the 1984 panel on Japanese Measures on Imports of Leather. ¹⁸

17. The complainants submitted that even if this panel adopted a narrow reading of Article III:5, first sentence, the second sentence was a broad requirement that the quantitative regulations not be contrary to the general principles of Article III:1. The DMA's minimum domestic content requirement was, according to the complainants, contrary to the principles of Article III:1. That Article required that domestic mixing and use provisions "not be applied to imported or domestic products so as to afford protection to domestic production". The minimum domestic use requirements of the United States, however, violated this principle since they permitted unlimited use of domestic tobacco without penalty, while providing substantial penalties for use of imported tobacco above the 25 per cent ceiling. Also, they required a manufacturer exceeding the 25 per cent ceiling to purchase specified quantities of domestic tobacco.

18. In addition, Canada submitted that, according to the USDA, 41 per cent of tobacco used to manufacture cigarettes in the United States in 1992 ¹⁹ had been provided from foreign sources. With the passage of the 1993 Budget Act, this figure would have to decrease to 25 per cent annually while the use of domestic tobacco would rise from 59 per cent to 75 per cent, thus benefitting domestic production at the expense of imported tobacco. Imported tobacco had been defined in the proposed regulations to include Oriental tobacco. In 1992, ²⁰ U.S. cigarette manufacturers had used 14 per cent Oriental tobacco and, according to Canada, this was likely to continue, given long-established consumer preferences. Since the 1993 Budget Act limited imported tobacco to 25 per cent of all tobacco used to manufacture cigarettes in the United States, only 11 per cent was left for other types of tobacco. The law thus disadvantaged exporters of flue-cured and burley tobaccos. Flue-cured tobacco leaf accounted for virtually all Canadian tobacco leaf exports to the United States. Canada also exported a significant quantity of tobacco refuse to the United States. With 14 per cent of the 25 per cent limit on imported tobacco expected to be taken by Oriental tobacco, the access of Canadian tobacco to the U.S. market would be severely restricted. Canada further submitted that the DMA undermined the competitive relationship between imported and domestic tobacco, contrary to a fundamental component of the national treatment obligation of Article III:2. The law had eliminated the price competitiveness of imports in the U.S. market by requiring domestic manufacturers of cigarettes to use 75 per cent U.S. grown tobacco, regardless of the price relationship between imported and domestic tobacco. No matter what the price of foreign tobacco, foreign producers would be unable to improve their competitive position vis-à-vis domestic tobacco producers. Thus, the DMA, by violating Article III of the General Agreement, nullified or impaired benefits accruing to Canada under the General Agreement.

19. Argentina, Brazil, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe submitted that the U.S. minimum domestic content requirement for cigarette manufacturers was also inconsistent with paragraph 4 of Article III of the General Agreement. According to the complainants, this provision generally prohibited contracting parties from discriminating against imported products and had been interpreted by panels in broad terms. For example, a panel had recently determined that internal regulations which merely posed a "risk" of discrimination against imported products were inconsistent with Article III:4. ²¹ Other GATT panels had determined that internal regulations which created a "preference" for the domestic product, or otherwise provided an "incentive" to purchase the domestic product, were inconsistent with Article III:4. ²² The minimum domestic tobacco content requirement of the United States was inconsistent with the requirements of Article III:4 since it discriminated between domestic and imported products after the imports had entered the customs territory of the United States. Section 1106(a) of the 1993 Budget Act created an incentive not to import any tobacco other than what was essential for flavour requirements. The United States had itself, in the past, argued that other countries' domestic content restrictions on cigarettes were inconsistent with the General Agreement. It had explicitly accepted the proposition that charges imposed by a government on the use of imported tobacco in the manufacture of cigarettes violated the General Agreement. A similar situation existed here. As described in paragraph 16 above, domestic manufacturers were subject to substantial penalties if they used more than 25 per cent imported tobacco in their products. This was discriminatory treatment which could not be justified under Article III:4.

20. Argentina, Brazil, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe submitted that the U.S. domestic content requirement (i.e. Section 1106(a) of the 1993 Budget Act) was also inconsistent with the prohibition in paragraph 2 of Article III, first sentence, against discriminatory internal taxes or charges since it imposed an "internal charge" in the form of monetary penalties and domestic purchase requirements when a manufacturer used more than 25 per cent imported tobacco in its cigarettes. A manufacturer that used 75 per cent or more of domestic tobacco in its cigarettes was not subject to these charges. The complainants considered that the penalties were internal, because they occurred well after the product had entered the customs territory of the United States. They were also charges, because they imposed monetary penalties that went directly to the U.S. Treasury. And they were discriminatory, because they were not applied to purchases of domestic tobacco. Concurrently, the complainants were of the view that the additional assessment and the purchase requirement could be seen as enforcement measures to use 75 per cent domestic tobacco. Canada noted and supported the arguments based on Article III presented by the co-complainants.

21. The United States considered that the DMA provision's additional assessment and purchase requirements should be viewed as enforcement measures for the underlying measure, and not as a form of tax or internal charge on a product within the meaning of Article III:2. Article III:2 did not include all enforcement measures involving civil fines or fees. Here, the assessments at issue were levied based on manufacturer liability, not on the basis of a "product", within the meaning of Article III:2. The United States referred to the report of the panel on Canada - Import, Distribution and Sale of Certain Alcoholic Drinks by Provincial Marketing Agencies ²³ which had decided to examine the underlying measure at issue first, making the examination of certain charges on beer containers unnecessary. According to the United States, in the current case an assessment under Section 1106(a) was not a charge on an import as such, but a charge applied to large U.S. manufacturers on the basis of their overall tobacco purchases. The complainants' concern appeared to be directed at the underlying treatment set forth in the provision, not the assessments which enforced the provision.

Budget Deficit Assessment (Section 1106(b)(1))

22. Argentina, Brazil, Canada, Chile, Colombia, El Salvador, Guatemala, Thailand and Zimbabwe submitted that the BDA ²⁴ was contrary to U.S. obligations under Article III:2 of the General Agreement since the tobacco products from the complainants and other contracting parties imported into the United States were thereby directly subject to internal taxes or other internal charges in excess of those applied to like domestic U.S. tobacco products. The Agricultural Act of 1949, as amended, imposed a marketing assessment on tobacco grown in the United States of one per cent of the national price support level for those tobacco crops for which price support was available. This assessment was divided equally between producers and purchasers of such tobacco. The 1993 Budget Act extended the assessment to imports of unmanufactured tobacco, regardless of type, the calculation of which resulted in the imposition of an internal tax or other internal charge, on imports of flue-cured tobacco in excess of those applied to like domestic flue-cured tobacco. While the budget deficit fee on imported burley tobacco (1.63 cents per pound) was less than the fee on domestic burley tobacco (1.683 cents per pound), the fee on imported flue-cured tobacco (1.63 cents per pound) was higher than the fee on domestic flue-cured tobacco (1.577 cents per pound). This was because the BDA on all types of imported tobacco was the sum of one-half of the domestic BDA on domestic burley and flue-cured tobacco. Mathematically, the assessment would always be higher on imported tobacco than on one type of domestic tobacco so long as there was any price differential between the average support price of burley and flue-cured tobacco. Citing prior panel decisions, the complainants were of the view that an internal tax on imported products that was higher than the internal tax on any like domestic products, was inconsistent with Article III of the General Agreement. ²⁵ Moreover, even if the lower assessment on imported burley tobacco, as compared to the assessment on domestic burley, were somehow considered to offset the higher import assessment on flue-cured tobacco, which, referring to prior panel findings, ²⁶ the complainants contested, the assessment on imported tobacco would necessarily always be higher than the assessment on some domestic tobacco since not all domestic tobacco was subject to a BDA. Domestic Maryland tobacco, for example, which was not subject to a price support programme, paid no BDA. Yet all imported tobacco was subject to the BDA. The complainants thus submitted that the BDA was an internal tax which was inherently higher on imported tobacco than on domestic tobacco, and it was consequently inconsistent with Article III:2 of the General Agreement. ²⁷

23. In addition, Canada, referring to Ad Article III:2, considered that Canadian flue-cured tobacco was a directly competitive or substitutable product with flue-cured tobacco from the United States. It competed in the same market as, and could be directly substituted for, U.S. flue-cured tobacco without any alteration in the manufacturing of cigarettes. Since importers of Canadian tobacco paid a BDA which was the sum of the assessment levied on purchasers of U.S. burley and flue-cured tobaccos, the imported tobacco was not "similarly" taxed, as purchasers of U.S. flue-cured tobacco paid only one assessment. This double taxation provided protection to the domestic product. By thus violating Article III:2, second sentence, benefits accruing to Canada under the General Agreement were being nullified or impaired. Further, Canada argued, the BDA on certain domestic tobaccos was limited by statute to each of the 1991 through 1995 crops, ²⁸ while Section 1106(b) of the 1993 Budget Act imposed a BDA on all imported unmanufactured tobacco for each of the 1994 through 1998 tobacco crops. Regardless of whether the "like domestic product" to imported flue-cured tobacco was domestic flue-cured tobacco or all unmanufactured tobacco, the application of a tax to imported products during a period when no domestic tax was applied to the like domestic product constituted, in Canada's view, discriminatory taxation inconsistent with Article III:2, first sentence.

24. The United States responded that the changes in the 1993 Budget Act with respect to the BDA were designed to equalize, at least in some small part, the competitive conditions for domestic and foreign tobacco, so as to ensure fair competition and not prejudice the continuation of the domestic price support programme and system of production controls. The BDAs as applied to imported tobacco were simply border tax adjustments to internal taxes or other charges, consistent with Article III:2 of the General Agreement. Since the BDA was "directly levied" on similar domestic tobacco, it was therefore eligible for border adjustment under the criteria described in a report of a GATT working party on border tax adjustments in 1970. ²⁹ The United States explained, as concerned the exclusion from the assessment of certain types of domestic tobacco referred to in paragraph 22 above, that this reflected, in contrast to flue-cured and burley tobaccos, that those types of tobacco did not participate in the price support programme. However, 98 per cent of US-grown tobacco was currently covered by support and control programmes. Although the actual BDA differed depending on the kind of tobacco involved, the difference was very small. Further, averaging of the BDA charges for two types of domestic tobacco in order to arrive at a single charge for imports was, according to the United States, a reasonable method of arriving at an assessment for the competing imported tobacco. As concerned the difference in termination dates for the BDAs for domestic and imported tobacco, the United States submitted that this was an anomaly resulting only from the legislative time-table surrounding the U.S. budget process and farm legislation. It could be expected that the BDA on domestic tobacco, enacted in connection with the 1990 Farm Bill, would be extended in the 1995 Farm Bill.

TO CONTINUE WITH MEASURES AFFECTING THE IMPORTATION, INTERNAL SALE AND USE OF TOBACCO

¹ Pub. L. No. 103-66.

² The legislation concerning these measures is annexed.

³ These loans were referred to as "non-recourse" since the tobacco was always retained in satisfaction of the loan amount and there was no further recourse against the producer.

⁴ Pub. L. No. 101-508.

⁵ 7 U.S.C. 1445.

⁶ 58 C.F.R. 68018 (December 23, 1993).

⁷ 7 U.S.C. 1445.

⁸ The "No Net Cost Tobacco Program Act of 1982, Pub. L. 97-218, 96 Stat. 197.

⁹ Consolidated Omnibus Budget Reconciliations Act of 1985, Pub. L. 99-272, 100 Stat. 86, April 7, 1986.

¹⁰ As a practical matter, purchaser NNCAs were identical to producer NNCAs, with one exception. For the 1993 crop, there was a technical correction to reflect that producers had more money in the account because they did not start contributing until after the 1985 Budget Act.

¹¹ Consolidated Omnibus Budget Reconciliation Act of 1985, Pub. L. 99-272, 100 Stat. 86, April 7, 1986.

¹² 7 U.S.C. 511r(d).

¹³ See paragraph 8 above.

¹⁴ Article III:5 of the General Agreement.

¹⁵ Report of the panel on EEC Measures on Animal Feed Proteins, ("Animal Feed" panel), adopted on 14 March 1978, BISD 25S/49.

¹⁶ Idem, paragraph 3.6.

¹⁷ Report of the panel on Italian Discrimination against Imported Agricultural Machinery, adopted on 23 October 1958, BISD 7S/60.

¹⁸ Report of the panel on Japanese Measaures on Imports of Leather, adopted on 15/16 May 1984, BISD 31S/94.

¹⁹ "Preliminary Regulatory Impact Analysis", Robert Miller, Tobacco and Peanut Analysis Division, United States Department of Agriculture, 1 December, 1993.

²⁰ Idem, page 1; and USDA "Tobacco Situation and Outlook Report", September 1993, cover page.

²¹ Report of the panel on European Economic Community Payments and Subsidies Paid to Processors and Producers of Oilseeds and Related Animal Feed Proteins, adopted on 25 January 1990, BISD 37S/86.

²² Report of the panel on European Economic Community Regulation on Import of Parts and Components, adopted on 16 May 1990, BISD 37S/132; report of the panel on Canada - Administration of the Foreign Investment Review Act, adopted on 7 February 1984, BISD 30S/140.

²³ Report of the panel on Canada - Import, Distribution and Sale of Certain Alcoholoic Drinks by Provincial Marketing Agencies, paragraph 5.33, adopted on 18 February 1992, BISD 39S/27.

²⁴ See paragraph 10 above.

²⁵ Report of the panel on EEC - Payments and Subsidies Paid to Processors and Producers of Oilseeds and Related Animal Feed Proteins, 125, paragraphs 140-141, adopted on 25 January 1990, BISD 37S/86. See also report of the panel on United States - Section 337 of the Tariff Act of 1930, adopted on 7 November 1989, BISD 36S/345, 387.

²⁶ Report of the panel on United States - Section 337 of the Tariff Act of 1930, adopted on 7 November 1989, BISD 36S/345.

²⁷ Report of the panel on United States - Taxes on Petroleum and Certain Imported Substances ("Superfund panel"), 155-159, adopted on 17 June 1987, BISD 34S/136.

²⁸ Section 106(g) of the Agricultural Act of 1949, 7 United States C. 1445(g)(1).

²⁹ Report of the working party on Border Tax Adjustments, paragraph 14, adopted on 2 December 1970, BISD 18S/97.