The question with regards to what extent does a duty drawback scheme constitutes a susbsidy was recently answered in the EU-PET case by the WTO. In question was the MBS Scheme, being an import duty remission program in Pakistan. It permitted the import of duty-free input material under the condition of its use for subsequent exports. The said scheme was in relation to polyethylene terephthalate,(usually referred to as ‘PET’) which is a form of polyester (just like the clothing fabric). Its potential uses are that it can be molded into plastic bottles and containers for packaging foods & beverages, personal care products, and many other consumer products.
Also notable is the fact that the Panel’s findings came after the measures were withdrawn inspite of EU’s efforts to dilute the process by arguing against processing Pakistan’s claims further as the measures stood expired. The Panel took a stand that if such a ruling is not made, the EU might come up with similar measures against Pakistan in the future. In context of this background, the author shall examine:
What is meant by the excess remission principle while determining a subsidy under the WTO rules?
What constitutes a subsidy under the SCM Agreement?
Background of the MBS Duty Drawback Scheme(Pakistan):
The EU had, in 2010 imposed countervailing duties on imports of polyethylene terephthalate (PET) from Pakistan and several other countries. Pakistan used to permit licensed companies to “import duty-free production input materials if such materials are consumed in the production of a product that is subsequently exported”. Pakistan remits the security to that company upon export of the company’s products if the company presents documents indicating that inputs for which remissions are requested were used in its production of the exports.
A Pakistani PET producer and exporter named Novatex used the MBS to obtain remissions of import duties on imported PET production inputs.
Based on a finding that Pakistan had “no effective implementation and monitoring system” to verify the amount of duty-free inputs actually used in subsequent exports nor proof of actual transactions, the Commission had treated the entire amount of import duties otherwise payable as revenue foregone.
Pakistan’s contention before the WTO was that only the “excess remission would constitute a subsidy” and not the entire amount of import duties.
FRAMEWORK OF A SUBSIDY UNDER THE SCM AGREEMENT:
Existence of a Subsidy:
A.1.1 of the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement), deems a subsidy to exist if there is a “financial contribution” by a government or a government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits) that confers a “benefit” on the recipient.
Footnote Number 1 of the SCM agreement (Additional Qualification):
The exemption of an exported product from duties or taxes borne by the like product when destined for domestic consumption, or the remission of such duties or taxes in amounts not in excess of those which have accrued, shall not be deemed to be a subsidy[1]. Clearly, Footnote Number 1 lays down the excess remission principle. The Excess Remissions Principle has been part of the multilateral trading system since mid-1950s, when it was included in an Interpretive Note to the GATT. During the Uruguay Round, it was memorialized in footnote 1 of the SCM Agreement[2].
To understand the dispute better, following arguments put forward by the two parties are of utmost importance:
Major Arguments by Pakistan:
With respect to duty drawback schemes like the MBS, footnote 1 of the SCM Agreement states a rule that a “financial contribution” for purposes of Article 1.1(a)(1)(ii) is limited to excess remissions[3].
Annex II nor Annex III do not provide any basis for departing from the rule stated in footnote 1,
Major Arguments by the EU:
That Footnote number 1 cannot be read alone and has to be read in agreement with Annexure I and Annexure II and when the three are read together subsidy can no longer mean that a subsidy can only exist when it is in the form of excess remissions[4].
That Pakistan had no effective system to check whether the Pakistan either have a reliable verification system to confirm what inputs Novatex used in producing its exported PET or conduct a further examination regarding that issue[5]. In the absence of effective verification systems or further examinations by the exporting Member, investigating authorities would have to rely on unverifiable information from companies to calculate excess remissions, inviting abuse of duty drawback schemes by companies[6].
Panel’s Findings:
Annex II(II)(1) indicates that investigating authorities should essentially: (a) determine whether the exporting Member has a system for tracking what inputs were consumed in the production of a relevant exported product; and (b) if such a system exists, evaluate its reliability. However, this guidance only applies, however, “[w]here it is alleged that … a drawback scheme, conveys a subsidy by reason of … excess drawback”, i.e the guidance presumes the excess remission principle.
Annex III is entitled “Guidelines in the Determination of Substitution Drawback Systems as Export Subsidies.Annex III(II)(3) provides:
“Where there are no verification procedures, where they are not reasonable, or where such procedures are instituted and considered reasonable but are found not to be actually applied or not applied effectively, there may be a subsidy. In such cases a further examination by the exporting Member based on the actual transactions involved would need to be carried out to determine whether an excess payment occurred”. The Panel found that even if Annex III provides incomplete guidance as to how to determine whether excess payments occurred under substitution drawback schemes, without some relatively clear indication to the contrary within Annex III’s focus of determining whether excess remissions occurred, this silence cannot be interpreted as substantively altering what amounts to a “subsidy” in Article 1 of the SCM Agreement[7].
To know the amount of the subsidy, the Panel laid down the following test of comparison: “between remissions of duties obtained by a company under a duty drawback scheme, on the one hand, and duties that accrued on imported production inputs used by that company to produce a subsequently exported product, on the other hand”. The Panel then went on to say that “subsidy exists insofar as the former exceeds the latter, i.e. an ‘excess’ remission occurs representing revenue forgone otherwise due. It concluded that the Excess Remission Principle was the final word on how remissions under duty drawback schemes are to be identified as subsidies.
It further held that a proper check on whether the duty drawback system was being properly administered in Pakistan was not a condition mentioned under the SCM Agreement and thereby the Excess Remission Principle should have been applied.
Noting that the Commission had failed to provide a reasoned and adequate explanation why it deemed the entire amount of remitted duties to have been ‘in excess of those which have accrued,’ the Panel concurred with Pakistan that the EU had incorrectly identified the existence of a financial contribution and, thus, of a subsidy contingent on export performance[8].
Concluding Remarks:
The Panel applied the Excess Remissions Principle strictly, allowing products to be countervailed only to the extent that the remission of duties obtained by a company under a duty drawback scheme is actually in excess of the duties that accrued on imported inputs. The decision reinforces the requirement that investigating authorities must have an appropriate evidentiary basis for their determinations[9]. Also notable is the fact that Pakistan had no proper system to check on the duty drawback scheme was not allowed to be taken as a defence when the Agreement clearly provided for the Excess Remissions Principle to be utilized which makes this decision revolutionary in its own different way. Whether the liberty provided with respect to the administration of such schemes shall be utilized or misutilized is something we’ll have to only wait and watch.
This post has been authored by Saumya Raizada a fourth year student of Hidayatullah National Law University, Raipur.
[1]Footnote Number 1, Agreement on Subsidies and Countervailing Measures.
[2]Brendan McGivern, White & Case, WTO Panel Report: EU — PET (Pakistan), https://www.whitecase.com/publications/alert/eu-pet-pakistan.
[3] Pakistan’s first written submission, para. 5.3; opening statement at the first meeting of the Panel, paras. 3.2 and 3.3.
[4] Para 7.32, Report of the Panel, European Union – Countervailing Duties On Certain Polyethylene Terephthalate From Pakistan, WT/DS486/R, (Published: July 6, 2017).
[5] Ibid.
[6] European Union’s first written submission, para. 95.
[7]Para 7.55, Report of the Panel, European Union – Countervailing Duties On Certain Polyethylene Terephthalate From Pakistan, WT/DS486/R, (Published: July 6, 2017).
[8] Folkert Graafsma and Joris Cornelis, The International Trade Law Review – Edition 3-Contents, THE LAW REVIEWS, (October 2017), https://thelawreviews.co.uk/edition/the-international-trade-law-review-edition-3/1148535/european-union.
[9]Brendan McGivern, WTO Panel Report: EU — PET (Pakistan), WHITE & CASE, ( July 11, 2017), https://www.whitecase.com/publications/alert/eu-pet-pakistan.
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