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Sarah Paterson*
In December 2002 the Appellate Body of the World Trade Organisation (WTO) issued its ruling in the long running dispute first initiated by New Zealand and the United States against Canada in 1997.1 The dispute related to Canada’s regulation of the domestic supply and export of milk, which New Zealand and the United States considered provided export subsidies to Canadian dairy products that were inconsistent with Canada’s obligations under the WTO Agreement on Agriculture.
On the basis of that ruling, Canada removed its subsidy scheme; a scheme that New Zealand had estimated was costing its farmers US$35 million a year in lost income. Not only did the dispute see the end of the Canadian subsidy scheme — it also sent a clear message to any other WTO Members who might have been contemplating adopting a similar scheme that if they did so they could expect to be successfully challenged.
The dispute was unique in several ways. It was the first and, until the initiation of the EC-Sugar dispute2 currently underway, the only time that Article 9.1(c) of the WTO Agreement on Agriculture had been the subject of WTO dispute settlement. It was also the first time that WTO Members in a dispute would take not one, but two “Article.5” proceedings in order to challenge Canada’s implementation of the initial Appellate Body ruling. For New Zealand, Canada-Dairy was the first time it had taken a dispute all the way to the Appellate Body. As it turned out New Zealand would argue its case before the Appellate Body three times before the subsidy would be effectively removed.
While there were a number of “firsts” for New Zealand and the dispute settlement system arising from the Canada-Dairy dispute, the Panel and Appellate Body rulings in this dispute have also contributed significantly to the WTO’s jurisprudence on export subsidies under the Agreement on Agriculture.
A WTO Panel was composed in 1998 to hear the dispute when consultations with Canada failed to resolve the issue. The Panel agreed with the claims of the United States and New Zealand that Canada was providing Article 9.1(a) and Article 9.1(c) export subsidies contrary to its obligations under the Agreement on Agriculture.4 In 1999 the Appellate Body upheld the Panel’s finding, but did so on the narrower grounds of a breach of Article 9.1(c) of the Agreement on Agriculture.5 From then on the focus of the dispute was solely Article 9.1(c).
The elements of Canada’s milk regulations that had been found to breach Canada’s obligations under the Agreement on Agriculture were called Special Milk Class 5(d) and 5(e). In summary, Canadian dairy processors obtained a permit allowing them to purchase milk under these Classes at a low price provided the processed product was then exported. The effect of this scheme was to subsidise the export of processed products by providing processors for export with lower priced milk. Under the WTO Agreement on Agriculture, export subsidies on agricultural products are generally prohibited, but some WTO Members retained the right to subsidise exports up to limits set in their schedules. As Canada did not count the Special Classes subsidies against its scheduled commitments Canada was providing export subsidies in breach of its Uruguay Round commitments.
Following the Appellate Body ruling Canada had until 31 January 2001 to bring itself into compliance — the ‘reasonable period of time’ provided for in Article 21.3(b) of the Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU). When that period expired Canada argued that, by removing Special Milk Class 5(e) and restricting exports under Class 5(d) to volumes within its export subsidy commitment levels, it had now complied with the ruling and was acting consistently with its WTO obligations. But at the same time Canada introduced another scheme (the new Commercial Export Milk (CEM) scheme), which would allow exports to continue.
Under the new scheme milk produced within production quotas could continue to be sold on the domestic market at a high, regulated price, while sales of milk to processors for export (CEM) no longer required a permit and the volume and price of those sales were negotiated between the producer and processor. Processors for export were exempt from paying the high domestic price for out-of-quota milk and were prohibited from diverting products made from such milk into the domestic market, leaving them no option but to export such products.
The effect of the new CEM scheme was therefore to continue to provide processors for export with lower priced milk. In the view of New Zealand and the United States, it was still an Article 9.1(c) subsidy. In February 2001 New Zealand and the United States initiated further dispute settlement proceedings against Canada under Article 21.5 of the DSU.6
Their claims were successful before the Panel,7 but on appeal the WTO Appellate Body reversed the Panel’s ruling on the basis that the Panel had applied the wrong test under Article 9.1(c).8 The Appellate Body then found itself without sufficient factual findings upon which to complete the analysis of the claims of New Zealand and the United States. Nor does the Appellate Body have any inherent power to remand issues back to the original panel for further consideration.
And so it was that in December 2001 New Zealand and the United States came to initiate a second round of Article 21.5 proceedings against Canada. A year later the Appellate Body ruled that Canada was indeed still providing export subsidies for dairy products inconsistently with its WTO obligations. In 2003 Canada and New Zealand (and separately Canada and the United States) reached a mutually agreed solution to the dispute following the complete the dismantling of Canada’s CEM scheme.9
At issue in the dispute was the meaning and scope of Article 9.1(c) of the Agreement on Agriculture. The Agreement on Agriculture contains strict disciplines on the use of export subsidies for agricultural products negotiated in the Uruguay Round.
Specifically, it requires that export subsidies listed in Article 9.1 — an extensive list of different types of export subsidy that a Member might use — must be subject to a commitment to reduce the level of the subsidy over specified periods of time. These reduction commitments are contained in a Member’s Schedule and under Article 3.3 of the Agreement Members have a legal obligation not provide export subsidies listed in Article 9.1 in excess of those levels. Article 8 of the Agreement contains an undertaking by all Members not to provide export subsidies otherwise than in conformity with the Agreement and their scheduled commitments.
Accordingly in order to successfully challenge Canada’s CEM scheme New Zealand and the United States had to demonstrate that exports were at levels that exceeded Canada’s reduction commitments, and that the scheme provided a subsidy listed in Article 9.1. Alternatively, if it was not an Article 9.1 subsidy, New Zealand and the United States had to show that the CEM scheme was an “export subsidy” being “applied in a manner which results in, or which threatens to lead to, circumvention of export subsidy commitments” within the meaning of Article 10.1 of the Agreement on Agriculture.
Although several panels had previously examined Article 10.3, the second recourse to Article 21.5 provided the Appellate Body with its first opportunity to consider it. Article 10.3 provides that:
Any Member which claims that any quantity exported in excess of a reduction commitment level is not subsidised must establish that no export subsidy, whether listed in Article 9 or not, has been granted in respect of the quantity of exports in question.
The Appellate Body found that there were two aspects to a claim under Article 10.3: a quantitative aspect (that the level of exports exceeds the commitment level) and an export subsidisation aspect (that exports over the commitment level are not being subsidised). The Appellate Body said that while under the usual rules on burden of proof a complaining Member would have to prove both aspects, Article 10.3 had “cleaved” the claim — and the burden of proof — in two, allocating the burden of proving the first aspect to the complainant and the second to the responding member.10
Accordingly New Zealand and the United States had only to prove that the level of Canadian dairy exports exceeded Canada’s reduction commitment levels for dairy products, and then it was for Canada to prove that no subsidy has been provided to the products exported in excess of Canada’s commitment levels. The Appellate Body even went so far as to say that a complainant could succeed in its claim even if it presented no evidence (other than that exports were being made in excess of reduction commitment levels) if the responding Member failed to meet its legal burden of establishing no export subsidy has been granted to the excess quantity.11
This is an important clarification for complainants seeking to challenge WTO-inconsistent export subsidies, a task that would have been practically much more difficult had Article 10.3 not operated to relieve complainants of any positive burden of proving the existence of a subsidy. The Appellate Body also recognised the policy choice made by WTO Members underlying Article 10.3 — that Members exporting in excess of their reduction commitments would bear the consequences of any doubts concerning evidence of export subsidisation and thus have a strong incentive to ensure they can demonstrate that they are complying with those commitments.12
Article 9.1(c) describes an export subsidy that is subject to reduction commitments, namely “payments on the export of an agricultural product that are financed by virtue of governmental action, whether or not a charge on the public account is involved”. Accordingly three elements must be demonstrated under Article 9.1(c): that there are “payments”, that they are made “on the export of an agricultural product” and that they are “financed by virtue of governmental action”. In Canada-Dairy only the issues of whether there were “payments” being made and whether they were “financed by virtue of governmental action” were in dispute.
By the time the dispute had reached the stage of the Second Recourse under Article 21.5 a significant body of jurisprudence had built up as to what constitutes a “payment” under Article 9.1(c). Most importantly it had been recognised that a “payment” “encompasses ‘payments’ made in forms other than money, including revenue foregone”.13 In the first proceedings challenging the Special Milk Classes the Appellate Body had concluded that when goods or services (in this case milk) are supplied at reduced rates, there is a “payment” to the recipient of the portion of the price that is not charged. Sales of milk under Special Classes 5(d) and (e) to processors for export were discounted relative to the higher regulated price of milk on the domestic market and thus “payments” were found to exist.
The key issue in the subsequent challenges to the new CEM scheme was that Canada no longer set the price that processors for export had to pay for milk. Rather, the market determined the CEM price. Accordingly the issue became what benchmark should be used to determine whether or not milk was being provided at “discounted” or “reduced” rates.
The Panel in the First Recourse to Article 21.5 concluded that the right benchmark for determining a “payment” was comparison between the price of CEM milk and the price at which producers in the domestic market sold milk.14 The Appellate Body rejected this benchmark. It said that the issue was whether the price charged by the producer of the milk is less than the milk’s proper value to the producer.15 The domestic price was fixed by the Canadian Government and reflected policy choices rather than economic considerations and therefore provided no guidance on whether the milk was being sold for less than its proper value.
Instead the Appellate Body looked for “some objective standard or benchmark which reflects the proper value of the goods or services to their provider...”,16 and found it in the average total cost of producing the product concerned. That was because the average total cost of production reflected the product’s proper value to the producer in that a failure to recoup that amount would result in the producer making losses.17
However the Appellate Body did not have before it sufficient facts upon which to determine whether sales of CEM milk were being made at less than the average total cost of producing that milk, thus forcing New Zealand and the United States to take a second case under Article 21.5. Armed with the new “average total cost of production” benchmark in the Second Recourse to Article 21.5, both the Panel and Appellate Body concluded that “payments” were being made under Article 9.1(c).
Guidance had also developed over the course of the dispute as to the meaning of this element of Article 9.1(c). It was not sufficient only to demonstrate the existence of “payments”: they must also be “financed by virtue of governmental action”.
The Appellate Body interpreted this element as requiring the existence of a “demonstrable link” between the governmental action at issue and how payments are financed.18 Where producers sell a product at less than it costs to produce it they must finance that portion of their costs of production another way, or else make a loss. According to the Appellate Body, in order to be an export subsidy under Article 9.1(c), how the producer finances the foregone portion of the value of the product to them (ie the payment) must be demonstrably linked to governmental action.
The Appellate Body had acknowledged that it would be difficult to demonstrate such a link where the payment is a payment-in-kind, and all the more so when the payment-in-kind is made, not by the government, but by an independent operator (in this case processors for export).19 In the original challenge to the Special Milk Class scheme the Appellate Body found such a link existed because governmental action (determining the volume and price of sales to processors) was indispensable to every stage of the supply of milk to processors.
With the new CEM scheme the link was not so readily identifiable and it was in this respect that the concept of “cross-subsidisation” became significant in the dispute. The Appellate Body found that such a link did exist because Canadian governmental action, in controlling and managing the domestic supply of milk, created a situation where cross-subsidisation could occur. Producers could sell their milk to processors for export at less than it cost to produce it, because they were getting a highly remunerative price for their milk in the domestic market. Thus it was by “virtue of governmental action” that the “payments” were being “financed”.
Article 3.2 of the DSU provides that dispute settlement serves to “clarify the existing provisions” of the WTO Agreements. While it took much longer than the parties could have anticipated, the three panel and Appellate Body proceedings that it took to resolve the dispute were able to substantially clarify the provisions of the Agreement of Agriculture at issue.
The Canada-Dairy dispute also demonstrated that the disciplines on agricultural export subsidies so hard fought for in the Uruguay Round were robust and could be effectively enforced. For New Zealand, with an economy reliant on agricultural exports, this was a significant outcome over and above achieving the removal of Canada’s subsidy scheme
* Sarah Paterson LLB/BA (Hons) (Otago) is a legal adviser in the Ministry of Foreign Affairs and Trade and specialises in international trade law. The Canada-Dairy case was the first of a number of WTO Dispute Settlement cases that Sarah has worked on for New Zealand since returning to Wellington in 2002, having completed a three year posting to the New Zealand Mission to the United Nations in New York where she was New Zealand's representative to the UN Third (Human Rights) Committee. More recently Sarah has been actively involved for New Zealand in the successful WTO challenge mounted against United States steel safeguards, as well as preparing New Zealand "third party" submissions in recent disputes initiated by other WTO Members in relation to US subsidies to the cotton sector, Japan's SPS measures applied to apple imports and EU subsidies to the sugar sector. She can be contacted at sarah.paterson@mfat.govt.nz.
1 Report of the 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-Dairy (21.5) II) WT/DS103/AB/RW2, WT/DS113/AB/RW2, adopted 17 January 2003.
2 European Communities – Export Subsidies on Sugar (WT/DS265, WT/DS266, WT/DS283).
3 A full history of the dispute is available on the website of the Ministry of Foreign Affairs and Trade: <www.mfat.govt.nz/support/legal/disputes/wtodispute>.
4 Panel Report, Canada – Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WT/DS103/R, WT/DS113/R (Canada – Dairy) adopted as modified by the Appellate Body, 27 October 1999.
5 Report of the Appellate Body, Canada – Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WT/DS103/AB/R, WT/DS113/AB/R (Canada – Dairy) adopted 27 October 1999.
6 Article 21.5 provides, in relevant part, that: Where there is disagreement as to the existence or consistency with a covered agreement of measures taken to comply with the recommendations and rulings such dispute shall be decided through recourse to these dispute settlement procedures, including wherever possible resort to the original panel.
7 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 (Canada – Dairy (21.5) I) adopted as modified by the Appellate Body, 18 December 2001.
8 Report of the Appellate Body, 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 (Canada – Dairy (21.5) I) adopted 18 December 2001.
9 See “Notification of Mutually Agreed Solution” WT/DS113/33,15 May 2003.
10 Report of the Appellate Body, Canada – Dairy (21.5) II, para 71-72.
11 Ibid, para 75.
12 Ibid, para 74.
13 Report of the Appellate Body, Canada – Dairy, para 112.
14 Panel Report, Canada – Dairy (21.5) I para 6.22.
15 Report of the Appellate Body, Canada – Dairy (21.5) I, para 73.
16 Ibid, para 74.
17 Ibid, para 87.
18 Report of the Appellate Body, Canada – Dairy (21.5) I, para 113.
19 Ibid.
The Canada-Dairy Dispute
New Zealand Yearbook of International Law
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