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5 December 2018

EU – PET (Pakistan) DS 486. WTO Appellate Body Report

What is the case about?

The EU – PET (Pakistan) (DS486) dispute concerns issues relating to countervailing measures imposed by the EU on imports of certain polyethylene terephthalate (PET)[1] from Pakistan in response to subsidies granted by the Government of Pakistan to domestic industry.

Pakistan has previously challenged before the Panel the consistency of countervailing measures imposed by the EU with certain provisions of the WTO Agreement on Subsidies and Countervailing Measures (the “SCM Agreement”). In fact, Pakistan disagreed with the very existence of the export subsidy, in particular, the existence of a financial contribution.

The Panel report was subject to appeal by both parties. On appeal, the EU stated that the Panel violated Art. 11 of Understanding on Rules and Procedures Governing the Settlement of Disputes (the “DSU”), by deciding to make findings on Pakistani claims, notwithstanding the expiry of the measure at issue during the Panel proceedings. The EU argued that the whole Panel Report was moot and of no legal effect. In addition, the parties challenged the legal interpretation of an export subsidy and the causal link.

Background

In 2009, the European Commission conducted a countervailing duty investigation on imports of PET from Iran, Pakistan and the United Arab Emirates. The European Commission investigated whether there was a subsidy separately for each country, calculated the injury margin and analysed the existence of any causal link.

In particular, the European Commission investigated seven different schemes that allegedly involved the granting of subsidies by the Government of Pakistan. One such scheme challenged before Panel and Appellate Body was the Manufacturing Bond Scheme (MBS).

The MBS is a so-called duty drawback scheme. The MBS permits licensed companies to import duty-free production input materials if such materials are consumed in the production of a product that is subsequently exported. The European Commission established that the Government of Pakistan granted the MBS to the Pakistani manufacturer Novatex, particularly for such inputs as purified terephthalic acid and mono ethylene glycol.[2]

Under MBS rules, the producing company deposits securities and cheques to the Pakistani Customs Department upon importation of inputs that will be applicable for three years and cover the general amount of import duty and sales tax applicable to such imported inputs.

At the time of exportation, the producing company must prepare a declaration certifying the consumption of inputs in the finished products under the MBS. As a next step, Pakistani customs officials examine the Goods Declaration on exports as well as the consumption sheet of the inputs used in manufacturing of the finished goods. Thereafter, the Pakistani customs officials release the indemnity bond and the post-dated cheques deposited at the time of the importation of the inputs to producing company. The European Commission concluded that the costs of inputs consumption were provided by the exporting company in the customs authorities under the theoretical calculation without due confirmation of actual inputs consumption. In turn, it lead to the remission in excess of the amount of import duties to be paid. The European Commission ruled that such excess remission is a financial contribution in the form of government revenue foregone. The European Commission also established that the Pakistani producer of PET Novatex benefited from this subsidy. It was impossible to establish the precise amount of the granted subsidy because Pakistan lacked an effective monitoring system of remissions under the MBS. The Government of Pakistan explicitly recognized the problem and at the end of the countervailing duty investigation even informed the European Commission about amendments to the MBS rules aimed at improving the control system over the MBS. However, the European Commission ruled that such amendments will not improve the main drawbacks of the MBS, notably: (1) the lack of reliable data as to imported inputs; (2) the lack of monitoring system which would help in obtaining actual rather than theoretical rates of input costs.

Having confirmed the existence of a subsidy, injury caused to the Union industry and the causal link, the European Commission imposed countervailing duty of 44,02 EUR per tonne on PET originating in Pakistan.

Disagreeing with the EU approaches, Pakistan lodged a challenge with the WTO over the imposition of countervailing measures by the EU as well as certain other aspects of the investigation.

Is there any legal basis for the MBS to be deemed an export subsidy?

On appeal, the EU disputed the conclusions of the Panel that the European Commission violated Art. 1.1 (а) (1)(ii)  of the SCM Agreement by determining MBS as an export subsidy. Under WTO law, a subsidy consists of a financial contribution made by a government that confers a benefit to the recipient of the subsidy. The Panel found that the European Commission wrongly analysed the financial contribution.

One of the forms of financial contribution by the government[3] is when government revenue that is otherwise due, is foregone or not collected pursuant to Art. 1.1 (а) (1) (ii) of the SCM Agreement. According to footnote 1 of this provision, 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 that have accrued is not deemed a subsidy. Instead, the remission of such duties and taxes “in amounts in excess of” those destined for domestic consumption shall be deemed as a financial contribution.

The European Commission determined the Pakistani MBS as a subsidy because the amounts of duties and taxes returned by the government to Pakistani exporters for imported materials used as an input in the exported products was in excess of the amounts to be paid for import into Pakistan. This situation occurred due to some imperfections of the government monitoring system for input consumption and the producers’ overestimation of the consumed inputs.

Moreover, the EU argued that the whole amount should be deemed a financial contribution since under the existing monitoring system it was impossible to determine the amounts of such “overestimation”. The EU was of the position that since the SCM Agreement (in particular, Annexes II-III) do not explain how to establish the “overestimation” in case of absence of the monitoring system, there is no need to establish such “overestimation” at all. Consequently, the EU deemed the whole amount of unpaid duties as an export subsidy.

The Appellate Body upheld the findings of the Panel that the European Commission violated Art. 1.1 (а) (1) (ii) of the SCM Agreement, since it did not provide reasoning why the whole amount of unpaid duties was deemed a financial contribution under the MBS and did not confirm that this amount was “in excess of” the charged amount of duties. Furthermore, the European Commission violated Art. 3.1(а) of the SCM Agreement since the existence of an export subsidy was determined based on a wrongful analysis of the financial contribution.

Moreover, the Appellate Body underlined the importance of defining the amounts “in excess of those which have accrued” when conducting analysis of the subsidy in the form of “duty drawback scheme” even if the exporting country does not possess an effective monitoring system for material inputs consumption in the production of the end products destined for exports.

The European Commission’s approach to causation analysis

On appeal, Pakistan disputed the Panel’s finding on the European Commission’s “break the causal link” approach. Pakistan argued that this approach precluded the European Commission from the correct analysis of other factors, except subsidized import, causing injury to the domestic producer and thus resulted in a breach of Art. 15.5 of the SCM Agreement.

Art. 15 of the SCM Agreement provides for the general approach to injury calculation in countervailing duty investigations and, in turn, regulates determination of the “causal link”. Pursuant to Art.15.5 of the SCM Agreement, the investigating authorities shall examine that the injury was caused by the subsidized import in such a way that other factors were not attributed thereto. Thus, the investigation authority shall examine not only the causal link between the subsidy and the injury, but also the causal link between other factors and the injury to domestic industry.

The European Commission examined whether the following factors cause injury to the domestic producer of PET:

  1. export activity of the EU industry;
  2. imports from Korea and other third countries;
  3. competition from non-cooperating producers in the European Union;
  4. the economic crisis in 2008;
  5. the geographical location of the EU industry;
  6. the lack of vertical integration etc.

The European Commission found that the injury caused to the domestic producer by the economic crisis in 2008 and the imports from Korea was of the limited degree, which did not “break the causal link” between the subsidised imports of PET and the injury.

Pakistan argued that if other factors could break the causal link, then such a link did not exist. According to Pakistan, this approach precluded the European Commission from assessing the effects of the subsidized imports, since the effects of other factors were evaluated individually and not aggregated as opposed to the general effects of subsidized imports.

The Appellate Body, having upheld the decision of the Panel, stated that pursuant to Art. 15.5 of the SCM Agreement, the investigating authority shall establish “the genuine and substantial relationship of cause and effect” between the subsidized imports and injury to the domestic industry.[4] Accordingly, it requires (1) examination of the link between the subsidized imports and the injury, and (2) examination of the other factors attributable to the injury of the domestic industry. Following this provision, the investigating authority is able to determine whether the domestic industry in fact suffers from subsidized imports.

The Appellate Body stressed that Art. 15.5 of the SCM Agreement does not prescribe any particular methodology an investigating authority must use in carrying out such analysis.[5] For instance, in countervailing duty investigation on import of PET the European Commission first determined (1) whether there is a “causal link” between the subsidized imports and the injury, and then (2) analysed all other factors. The Panel underlined that the initial analysis of the link between the subsidy and the injury was not final to preclude the EU from considering all other factors.

The Appellate Body agreed with the Panel, that the “break the causal link” approach does not violate the provisions of Art.15.5 of the SCM Agreement and dismissed this part of the complaint.

Is it acceptable to challenge expired measures?

WTO Members still take different positions regarding the possibility of challenging expired measures under the WTO dispute settlement system.

Importantly, the WTO dispute settlement system lacks a compensation mechanism for affected parties. The Panels and the Appellate Body usually recommend that parties bring measures in conformity with the relevant violated WTO agreements. In accordance with Art. 3.7 of the DSU, the first objective of the dispute settlement mechanism is to secure the withdrawal of measures concerned if these are found to be inconsistent with the provisions of any of the covered agreements. In other words, the review by the Dispute Settlement Body of expired measures lacks practical rationale.

In practice, panels often consider the time when the challenged measure has expired. In particular, in the case EC – Fatty Alcohols (Indonesia) the measures at issue expired after circulation of an interim report to the parties. On appeal, the EU in EC-Fatty Alcohols (Indonesia) claimed that it makes no sense to appeal the panel report given that the measures at issue expired. However, the Appellate Body stated that it is at the discretion of the Panel to decide whether to consider subsequent changes and the withdrawal of the respective measures. Considering that it was found that challenged measures violated the requirements of certain WTO agreements, the Panel had no reasons not to make recommendations according to Article 19.1 of the DSU.

In the present case, EU – PET (Pakistan), the challenged measures expired after the composition of the Panel but before the publication of the report. The Panel decided to review the expired measure based on the following reasoning: (1) the measures at issue expired after the panel’s establishment, (2) Pakistan insisted on the Panel’s conclusions regarding the expired measures and (3) the dispute was on a fundamental level. The Panel also considered that there is a risk of reimposition of the expired measures in similar circumstances to the challenged ones. The Appellate Body in general agreed with the Panel’s reasoning and did not find a violation of Art. 11 of the DSU.[6] At the same time, both the Appellate Body’s and the Panel’s reports lack recommendations regarding the challenged measures.

The Appellate Body Report also contains a dissenting opinion of one Appellate Body Member who did not agree with the conclusion of the Appellate Body with regard to the present issue. In his view, the Panel had to check whether it is still necessary to resolve the dispute following the expiry of the measure at issue.[7]

Significance of the dispute or what has Pakistan gained?

Neither the Panel nor the Appellate Body made recommendations with regard to implementation of the Reports, considering that countervailing measures expired before the Panel commenced its work over the case. Nevertheless, the position of both the Panel and the Appellate Body regarding the possibility to consider the expired measure is of particular significance to the WTO dispute settlement practice.

Importantly, the Appellate Body elaborated on the application of the SCM Agreement. Given that the SCM Agreement lacks a mechanism for calculation of an ‘excess’ remission over the amount of paid duties, the Appellate Body explained that it is necessary to evaluate a financial contribution when calculating the subsidy, even in the absence of precise data for such analysis.

Please contact Anzhela Makhinova or Ivan Baranenko for further information.

[1] PET is a chemical product used in the plastic industry. It is the main input in production of photo, aerial and x-ray films

[2] The main material inputs in production of PET.

[3] Financial contribution pursuant to Art.1. (а) 1 of the SCM Agreement can be provided in different forms, which includes government grants, purchase of goods and services by the government, different funding and crediting mechanisms etc.

[4] Appellate Body Report, EU-PET, para. 5.226

[5] Appellate Body Report, EU-PET, para. 5.227

[6] Appellate Body Report, EU-PET, para. 5.52

[7] Appellate Body Report, EU-PET, paras. 5.54-5.61

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