(i) General outline

7.24 As this is the first case brought before a panel which involves the substantive provisions of the Agreement on Agriculture relating to export subsidies, we consider it appropriate to provide an outline of these provisions. They form part of the context within which the specific provisions invoked by the complainants and the related claims must be addressed. They also reflect the object and purpose of the Agreement on Agriculture, another element we need to take into account when examining the issues before us. ³⁷⁹

7.25 As enunciated in the preamble to the Agreement on Agriculture, the main purpose of the Agreement is to "establish a basis for initiating a process of reform of trade in agriculture" ³⁸⁰ in line with, inter alia, the long-term objective of establishing "a fair and market-oriented agricultural trading system". ³⁸¹ This objective is pursued in order "to provide for substantial progressive reductions in agricultural support and protection sustained over an agreed period of time, resulting in correcting and preventing restrictions and distortions in world agricultural markets". ³⁸²

7.26 The general aim of the Uruguay Round negotiations on agriculture was to "achieve greater liberalisation of trade in agriculture and bring all measures affecting import access and export competition under strengthened and more operationally effective GATT rules and disciplines". ³⁸³ In the case of export competition this was to be achieved by "improving the competitive environment by increasing discipline on the use of all direct and indirect subsidies and other measures affecting directly or indirectly agricultural trade, including the phased reduction of their negative effects and dealing with their causes". ³⁸⁴ The results of these negotiations take the form of: (i) the specific binding reduction commitments on both export subsidies and domestic support which have been incorporated in Members' Schedules pursuant to Article 3.1 of the Agreement on Agriculture as constituting "commitments limiting subsidization"; and (ii) the rules set out in the Agreement on Agriculture itself, which are designed to protect the scheduled commitments and provide a new framework to govern the use of agricultural export subsidies and domestic support.

7.27 The fundamental general provision of the Agreement on Agriculture concerning export subsidies is Article 8:

Article 1(e) of the Agreement defines the term "export subsidies" ("unless the context otherwise requires") as referring to: "subsidies contingent upon export performance, including the export subsidies listed in Article 9 of this Agreement". This listing of export subsidies and the related base period for subsidised export quantities and budgetary outlays served as the basis for the establishment of the scheduled Uruguay Round reduction commitments. Under Article 9.1 the following export subsidies are subject to reduction commitments under the Agreement:

7.28 By virtue of Article 3.3 of the Agreement, the list in Article 9.1 lays the foundation for the core rules of the Agreement relating to export subsidies. Article 3.3 provides:

7.29 The Article 3.3 prohibition relates exclusively to the export subsidies listed in Article 9.1. All other subsidies contingent upon export performance as defined in Article 1(e) of the Agreement are subject to the provisions of Article 10 relating to the prevention of circumvention of export subsidy commitments. Article 10.1 provides as follows:

Thus, a Member may use export subsidies not listed in Article 9.1 within the limits of its scheduled reduction commitments. However, as stipulated by Article 10.1, such subsidies may not be applied so as to circumvent these and other export subsidy commitments under the Agreement on Agriculture.

(ii) The specific provisions relied upon by the parties

7.30 Both complainants invoke Articles 3.3, 8, 9.1 and 10 of the Agreement on Agriculture, quoted above.

7.31 Since Article 9.1 sets out the explicit reduction commitments entered into by Canada, as opposed to Article 10 which deals with circumvention of those commitments, we shall first examine whether the Special Milk Classes Scheme involves an export subsidy listed in Article 9.1. Both complainants also first address Article 9.1. We prefer this sequence to Canada's approach of first examining whether the scheme is a "subsidy" more generally with particular reference to the SCM Agreement. What needs to be examined here in the first place is whether an "export subsidy" is provided for quantities of exports of agricultural products in excess of the reduction commitments made by Canada under the Agreement on Agriculture. In our view, the most specific and appropriate language provided to make this determination is found in Article 9.1 of the Agreement on Agriculture - setting out specific practices as "export subsidies" explicitly made subject to Canada's reduction commitments -; not in Article 1 of the SCM Agreement pursuant to which certain practices are deemed to be a "subsidy" for purposes of the SCM Agreement.

4. Burden of proof as a consequence of Article 10.3 of the Agreement on Agriculture

7.32 We note, prior to our analysis of Article 9.1, that Article 10.3 provides as follows:

7.33 This provision shifts the burden of proof from the complainant to the defendant. A defending party (i.e., the exporting country) alleging that exports in excess of its reduction commitment level are not subsidized must demonstrate that no export subsidy in respect of this excess has been granted. All parties in dispute agree that the wording of Article 10.3 has this effect of reversing the usual burden of proof. ³⁸⁵

7.34 In this dispute, all parties agree that the actual exports of butter, cheese and "other milk products" made by Canada, exceed Canada's reduction commitment levels and this for both marketing years at issue (1995/1996 and 1996/1997). ³⁸⁶ Canada claims that these quantities exported in excess of its reduction commitment levels are not subsidized. It is thus for Canada to establish that the quantity of exports exceeding its commitment levels has not been made subject to "export subsidies". In other words, for purposes of the claims before us, it is for Canada to present evidence sufficient to establish a presumption that the Special Milk Classes Scheme does not involve an "export subsidy, whether listed in Article 9 or not". Once such presumption is established, it is for New Zealand and the United States to present evidence to rebut this presumption. ³⁸⁷ New Zealand and the United States responded in extenso to the claim that the export quantities in question are not subject to export subsidies. Thus, our task is essentially to weigh the evidence and determine whether Canada has met the burden imposed by Article 10.3.

5. Article 9.1(a) of the Agreement on Agriculture

7.35 The complainants rely on Article 9.1(a) and (c). Both provisions define a type of export subsidy that is subject to Canada's reduction commitments. The parties do not disagree that there may be some degree of overlap between various sub-paragraphs of Article 9.1. The complainants submit that the provision of milk under Classes 5(d) and (e) of the Special Milk Classes Scheme involves export subsidies under both Article 9.1(a) and Article 9.1(c).

7.36 We first examine whether there is an Article 9.1(a) export subsidy at issue. Article 9.1(a) subjects the following type of action to Canada's export subsidy reduction commitments:

7.37 The complainants submit that in this case Canadian government agencies - in particular, the Canadian Dairy Commission ("the CDC") and the provincial milk marketing boards acting under delegated authority - make milk available to processors/exporters under Classes 5(d) and (e) at prices lower than the prevailing domestic milk price. In their view, this constitutes an export subsidy under Article 9.1(a).

7.38 Under Article 9.1(a), an export subsidy exists if the following conditions are fulfilled:

7.39 The record shows that milk is made available to processors/exporters under Classes 5(d) and (e). We consider that Article 9.1(a) applies to processors and exporters as either "a firm", "an industry" or "producers of agricultural products". We note that no party argued that producers or exporters were to be excluded from the application of Article 9.1(a). We thus find that the third condition under Article 9.1(a) is met in the instant case.

7.40 The record also shows, and Canada does not argue otherwise, that lower priced milk under Classes 5(d) and (e) is only available to processors for the processing of dairy products which will be exported. Accordingly, access to milk at a discounted price under Classes 5(d) and (e) is "contingent on export performance" in the sense of the fourth condition under Article 9.1(a). Milk for the production of dairy products to be sold on the Canadian market is only available at a higher price under one of the other milk classes (Classes 1 to 5, excluding 5(d) and (e)). A processor that buys milk under Classes (d) or (e), but subsequently uses the milk for domestic purposes, has to pay the price differential up to the level of the domestic milk price, plus interest calculated on the price differential starting from the time of transaction to the date of payment. ³⁸⁸

7.41 The United States also makes claims under milk classes other than Classes 5(d) and (e). In this regard, we note that milk under such other classes is also available (often exclusively) to processors which produce for the domestic market. Accordingly, access to milk under such other classes is not "contingent on export performance". We therefore find that such other milk classes do not involve an export subsidy under Article 9.1(a).

7.42 The question is then whether the availability of milk under Classes 5(d) and (e) also meets the first and second conditions of Article 9.1(a): (i) does it provide "direct subsidies, including payments-in-kind"; and (ii) are such direct subsidies provided "by governments or their agencies"?

(a) "direct subsidies, including payments-in-kind"

(i) General criteria

7.43 The plain language of Article 9.1(a) makes clear that "payments-in-kind" are a form of direct subsidy. Hence, a determination in the instant matter that "payments-in-kind" exist would also be a determination of the existence of a direct subsidy.

7.44 We first note that, when referring to subsidies (as Article 9.1(a) does), the ordinary meaning of the term "payment" cannot reasonably relate to a "payment" as the term is understood in contract law (e.g., pay for labour or the price of a good). Rather, it connotes a gratuitous act, a bounty or benefit provided, for example, in pursuit of a policy objective (e.g., in the area of export subsidies, the stimulation of exports to dispose of surpluses in the domestic market). A reading of Article 9.1(a) to the effect that a "payment" exists only if a benefit is granted, is further mandated by the general context of this provision which includes Article 1 of the SCM Agreement. ³⁸⁹ That provision explicitly requires that a "benefit" be conferred for there to be a "subsidy" under the SCM Agreement. ³⁹⁰

7.45 Secondly, the term "payments-in-kind" in Article 9.1(a) must be ordinarily construed to include payment in goods or labour as opposed to payment of money. ³⁹¹ We agree with the complainants that both the provision of a good at no price and the provision of a good at a price lower than the normal price (whatever this normal price may be) can be considered as a payment in kind.

(ii) Milk sales under Special Milk Classes 5(d) and (e): the provision of milk for the processing of dairy products for export at a lower price

7.46 In the present case, no money is given gratuitously to processors/exporters. However, the complainants submit that under the Special Milk Classes Scheme processors/exporters receive a payment in kind, namely milk at a price which is lower than that of milk sold for use on the domestic market .

7.47 We noted above that a benefit must be conferred for a payment in kind to exist in the sense of Article 9.1(a). ³⁹² In this case, the question thus arises whether the provision of milk to processors/exporters under Classes 5(d) or (e) confers a benefit to these processors/exporters. This, in turn, raises the question of what the appropriate benchmark is for determining whether the provision of a good at a certain price confers a benefit. ³⁹³ Does it suffice, as the complainants argue, that milk for export use is provided to processors at a price below the domestic milk price for there to be a benefit conferred to these processors (hereafter referred to as "the first benchmark", namely the domestic milk price)? Or, does one need to establish that processors/exporters receive milk under Classes 5(d) and (e) at a price which is not only lower than the domestic milk price, but also lower than the price of milk these processors/exporters can obtain from any other source, in particular the price of milk they can source from the world market (hereafter referred to as "the second benchmark", namely the lowest milk price to be obtained from any other source)?

7.48 If milk were provided below the lowest milk price to be obtained from any other source (i.e., below the second benchmark), it would a fortiori be provided below the domestic milk price (i.e., below the first benchmark). In other words, if we were to find that milk is provided below the second benchmark, there would be no need to further examine whether it is also provided below the first benchmark. Without making a finding on the issue of the appropriate benchmark we shall, therefore, in the first instance, proceed on the assumption that the second benchmark, although more favourable to Canada, is appropriate in the circumstances. In our view, if the price of milk under Classes 5(d) and (e) is lower than the price at which processors/exporters can obtain milk from any other source, a bounty or benefit - i.e., something they would otherwise not have obtained - would, indeed, be conferred. If this were the case, we consider that processors/exporters would be receiving "payments-in-kind" in the sense of Article 9.1(a).

7.49 We therefore next examine whether processors/exporters can access milk from any other source on terms and conditions, in particular prices, as favourable as those offered under Classes 5(d) and (e).

7.50 We note, first, that under Classes 5(d) and (e) milk is made available to processors for export at a significantly lower price than the price of milk for domestic use. ³⁹⁴ Canada does not contest this. Classes 5(d) and (e) thus make available milk at prices that are clearly below the first benchmark we referred to above. ³⁹⁵ Moreover, referring to the second benchmark, it is not disputed that sourcing milk from any of the other milk classes for use mainly on the domestic market (Classes 1 to 5(c)) would not offer processors/exporters the same favourable price as that of milk available under Classes 5(d) or (e). ³⁹⁶

7.51 Second, given the high tariffs applied by Canada to imports of fluid milk ³⁹⁷ (283.8 per cent, declining to 241.3 per cent in 2001), the price of milk under Classes 5(d) and (e) is not only significantly lower than the domestic milk price, it is also significantly lower than the duty paid price of imported fluid milk. Canada does not dispute this nor does it contest that for all intents and purposes the over-quota tariff rate it imposes on imports of fluid milk effectively precludes such imports. For purposes of the second benchmark, importing fluid milk cannot therefore be considered as a source of milk at the same favourable price as that of milk offered under Classes 5(d) or (e).

7.52 Canada submits that processors for export can access their milk inputs on equally favourable terms and conditions as those under Classes 5(d) and (e) under its special Import for Re-Export Program. ³⁹⁸ With respect to imports of fluid milk under this Program Canada acknowledges that "there have not been imports of raw industrial milk in recent years under the Import for Re-Export Program". ³⁹⁹ Canada argues, however, that under the Import for Re-Export Program processors/exporters can nonetheless import milk derivatives, such as skim milk powder, whole milk powder, butter and butter derivatives. According to Canada, these milk components are not different from milk, but part of the same product and can be used for the same manufacturing processes as milk.

7.53 We note that under the Import for Re-Export Program the decision as to whether fluid milk or milk derivatives may enter the Canadian market depends, first and foremost, on the discretionary authority of the Department of Foreign Affairs and International Trade. The statutory authority for the Program is contained in paragraph 8 of the Export and Import Permits Act. Paragraph 8 (1) allows the Minister responsible for the Act to "issue to any resident of Canada applying therefor a permit to import goods included in an Import Control List, in such quantity and of such quality, by such persons, from such places or persons and subject to such other terms and conditions as are described in the permit or in the regulations". ⁴⁰⁰ Canada states that the authority of the Minister to set these terms and conditions is not subject to any specified regulations. Therefore - even if imports of fluid milk and milk derivatives under the Import for Re-Export Program could in theory be made at an equally favourable price to the one offered under Classes 5(d) and (e) - the fact that the Minister has to issue a permit before such imports are allowed and that the Minister disposes of a wide discretion in doing so, is proof that these imports are not effectively available under equally favourable terms and conditions as those offered under Classes 5(d) and (e). After all, whether or not processors for export access fluid milk or milk derivatives under this Program depends, in the first place, not on commercial considerations (i.e., price), but on the discretion of Canadian authorities.

7.54 We further note that processors for export have so far never accessed fluid milk for commercial use under this Program. ⁴⁰¹ Canada argues that no such imports of fluid milk are made due to commercial reasons, namely, the high costs of transport of fluid milk. Canada also refers to the fact that fluid milk is of a perishable nature and thus of limited tradability. We note, however, that fluid milk could be imported from the United States (given its proximity to Canada). In view of the US claim before this Panel to have wider access to the Canadian market for fluid milk (under Canada's tariff-rate quota) ⁴⁰² , one can assume that imports of fluid milk are, in principle, technically and commercially viable. Nonetheless, under the Import for Re-Export Program no such imports are made. In our view, this indicates that the specific sales terms and conditions under the Program are clearly not commercially attractive relative to those offered under Classes 5(d) or (e).

7.55 In addition, with respect to access to milk derivatives under the Import for Re-Export Program, we note the Complainants' arguments that there are inherent differences between fluid milk - available under Classes 5(d) and (e) - and milk derivatives which can be imported under the Program. Skim milk powder, for example, does not contain any butterfat, thus requiring additional processing for its use in certain dairy products. Because fluid milk contains butterfat it is not subject to a similar constraint. Whole milk powder, on the other hand, does contain butterfat but since all liquid has been removed from it, for most end-uses it has to be rehydrated before it can be used. The same constraint applies to skim milk powder, but not to fluid milk. In both instances, additional time and cost are involved when using milk powder as an input rather than fluid milk. The United States further submits that the use of milk powder might also alter the flavour of the finished product from that which would be obtained by using fluid milk. Canada seems to acknowledge some of these elements when it states that "milk powders can be reconstituted for use in the manufacture of some dairy products ... Thus, to a certain extent, milk powders compete in the same markets and fulfil the same needs and uses as fluid industrial milk". ⁴⁰³

7.56 In our view, even if such milk derivatives were directly competitive with fluid milk, we note that (i) figures submitted by the United States indicate - albeit in general terms only - that the milk equivalent prices for the milk derivatives imported under the Import for Re-Export Program were, over the last four years, higher than the price of fluid milk provided under Classes 5(d) and (e) ⁴⁰⁴ ; and (ii) processors for export have revealed an overwhelming preference for Classes 5(d) and (e) milk, as opposed to sourcing inputs from the Program (exports generated with Classes 5(d) and (e) milk account for approximately 95 per cent of total actual exports). ⁴⁰⁵ Indeed, in our view, the fact that fluid milk and milk derivatives surplus to Canadian domestic requirements are regularly disposed of (without accumulation of stocks) raises a presumption that the terms and conditions available under Classes 5(d) and (e) are more favourable than those under the Import for Re-Export Program. The elements outlined above indicate that milk derivatives cannot, for all practical purposes, be sourced under the Program on equally favourable terms and conditions as those under Classes 5(d) or (e).

7.57 For the above reasons ⁴⁰⁶ , we find that Canada, in relation to Classes 5(d) and (e), has not met its burden ⁴⁰⁷ of establishing that the Import for Re-Export Program provides processors for export with access to milk - or even milk derivatives for that matter - on equally favourable terms and conditions as those available under Classes 5(d) or (e).

7.58 More generally - and for all the reasons outlined above ⁴⁰⁸ - we find that the provision of milk to processors/exporters under Classes 5(d) and (e) at a price significantly lower than the domestic milk price (i.e., below the first benchmark) and on terms and conditions which are more favourable than those under any other alternative source, including under the Import for Re-Export Program (i.e., below the second benchmark) - confers a "benefit" (in terms of both the first and second benchmarks we set out earlier ⁴⁰⁹ ) to these processors/exporters and, for that reason, constitutes a payment in kind - namely, the provision of a good at a discounted price - in the sense of Article 9.1(a).

To continue with Milk sales under Special Milk Classes 5(d)

³⁷⁹ In accordance with the principles of treaty interpretation contained in the Vienna Convention on the Law of Treaties (Article 31).

³⁸⁰ Preambular paragraph 1.

³⁸¹ Preambular paragraph 2.

³⁸² Preambular paragraph 3.

³⁸³ Punta del Este Declaration, Ministerial Declaration on the Uruguay Round, MIN.DEC, 20 September 1986, p. 6.

³⁸⁴ Ibid.

³⁸⁵ See, in particular, Canada's answer to Panel Question 14 to Canada.

³⁸⁶ See Table 2 in para. 2.41 above.

³⁸⁷ See Appellate Body report on United States - Measures Affecting Imports of Woven Wool Shirts and Blouses from India, adopted on 23 May 1997, WT/DS33/AB/R, pp. 13-14.

³⁸⁸ See Canada's answer to Panel Question 23 to Canada. In Quebec, the processor will also have to pay a penalty of $12/hL.

³⁸⁹ See para. 7.23.

³⁹⁰ Article 1.1(b) of the SCM Agreement provides: "For the purpose of this Agreement, a subsidy shall be deemed to exist if: ... (b) a benefit is thereby conferred".

³⁹¹ The New Shorter Oxford English Dictionary defines "in kind" as "in goods or labour as opp. to money; (b) in a similar form, likewise" (Ed. Brown, L., Clarendon Press, Oxford, Volume 1, p. 1489).

³⁹² See para. 7.44.

³⁹³ We note, in this respect, that Article 1.1(b) of the SCM Agreement - to which we referred when noting the requirement of a "benefit" being conferred in paragraph 7.44 above - only requires that there be a benefit in the general sense and that the benefit in fact be conferred by the measure or arrangement which is alleged to be a subsidy.

³⁹⁴ See Table 3 in para. 2.51.

³⁹⁵ See para. 7.47.

³⁹⁶ See Table 3 in para. 2.51.

³⁹⁷ Other than the fluid milk falling under the 64,500 tonnes tariff-rate quota which Canada restricts to cross border imports by Canadians of consumer packaged milk for personal use, valued at less than C$20 per entry.

³⁹⁸ See para. 2.11.

³⁹⁹ Canada's oral statement at the second substantive meeting, para. 74. In its comments on US Exhibit 56, Canada clarified that "much of the fluid milk imported under the Import for Re-export Program is imported in retail packages for use on cruise ships".

⁴⁰⁰ Emphasis added.

⁴⁰¹ See para. 7.52 and footnote 399.

⁴⁰² See paras. 7.142 ff.

⁴⁰³ Canada's answer to Panel Question 28(f) to Canada, emphasis added.

⁴⁰⁴ See US Exhibit 56. In our decision of 16 December 1998, outlined above in para. 7.17, we decided that we can take cognizance of the figures contained in this Exhibit. We carefully considered Canada's objections to these figures set out in Canada's comments of 23 December 1998. Although these figures seem to include certain inaccuracies and can therefore only provide a general indication, we do not consider that Canada's objections are so serious that no weight at all should be attached to Exhibit 56. We note, moreover, that Canada did not provide figures or indications to effectively rebut the general tendency shown by the US figures. Moreover, in the view of the Panel, the fact that some of the data supplied by Canada on exports under the Import for Re-Export Program related to imports and re-exports of dairy products by visiting cruise ships, casts doubt on the relevance of this data and of the Program itself.

⁴⁰⁵ See Canada's answers to Panel Questions 1 and 3(b) to Canada.

⁴⁰⁶ See paras. 7.52-7.56.

⁴⁰⁷ See para. 7.34.

⁴⁰⁸ See paras. 7.53-7.56.

⁴⁰⁹ See para. 7.47.