RESTRICTED
WORLD TRADE WT/CTE/W/16
1December 1995
ORGANIZATION(95-3888)
Committee onTrade andEnvironment
NEGOTIATING HISTORY OFFOOTNOTE 61OFTHE AGREEMENT ONSUBSIDIES
AND COUNTERVAILING MEASURES
Note bytheSecretariat
1. Thispaper hasbeenprepared attherequest oftheCommittee onTrade andEnvironment
forafactual account onthenegotiating history offootnote 61oftheWTO Agreement on
Subsidies andCountervailing Measures. Section Iofthepaper reproduces footnote 61andnotes
itslinkwithAnnex IoftheAgreement onSubsidies andCountervailing Measures. Section IIof
thepaper provides anegotiating history ofthefootnote.
I. FOOTNOTE 61OFTHE AGREEMENT ONSUBSIDIES AND COUNTERVAILING
MEASURES
2. Footnote 61oftheAgreement onSubsidies andCountervailing Measures ("Agreement") is
partofAnnex IIoftheAgreement, andclarifies thecoverage oftheterm"inputs consumed inthe
production process". Itstates: "Inputs consumed intheproduction process areinputs physically
incorporated, energy, fuelsandoilusedintheproduction process andcatalysts which are
consumed inthecourse oftheirusetoobtain theexported product."
3. Annex IIoftheAgreement provides "Guidelines onConsumption ofInputs inthe
Production Process", which address theissue ofindirect taxrebate orremission ordrawback of
import charges on"inputs thatareconsumed intheproduction oftheexported product". These
aspects arementioned initems (h)and(i)ofAnnex IoftheAgreement, which contains an
"Illustrative ListofExport Subsidies". According toitems (h)and(i)ofAnnex I,export
subsidies areprovided, interalia,inthefollowing situations:
"(h) Theexemption, remission ordeferral ofprior-stage cumulative indirect
taxes [footnote omitted] ongoods orservices usedintheproduction of
exported products inexcess oftheexemption, remission ordeferral oflike
prior-stage cumulative indirect taxes ongoods orservices usedinthe
production oflikeproducts when soldfordomestic consumption;
provided, however, thatprior-stage cumulative indirect taxes maybe
exempted, remitted ordeferred onexported products evenwhen not
exempted, remitted ordeferred onlikeproducts when soldfordomestic
consumption, iftheprior-stage cumulative indirect taxes arelevied on
inputs thatareconsumed intheproduction oftheexported product
(making normal allowance forwaste) [footnote omitted]. Thisitemshall
beinterpreted inaccordance withtheguidelines onconsumption ofinputs
intheproduction process contained inAnnex II.[emphasis added]
(i) Theremission ordrawback ofimport charges [footnote omitted] inexcess
ofthose levied onimported inputs thatareconsumed intheproduction ofWT/CTE/W/16
Page2
theexported product (making normal allowance forwaste); provided,
however, thatinparticular cases afirmmayuseaquantity ofhome
market inputs equal to,andhaving thesame quality andcharacteristics as,
theimported inputs asasubstitute forthem inorder tobenefit from this
provision iftheimport andthecorresponding export operations bothoccur
within areasonable timeperiod, nottoexceed twoyears. This itemshall
beinterpreted inaccordance withtheguidelines onconsumption ofinputs
intheproduction process contained inAnnex IIandtheguidelines inthe
determination ofsubstitution drawback systems asexport subsidies
contained inAnnex III."(emphasis added)1
4. Thereference totheterm"inputs thatareconsumed intheproduction oftheexported
product" inAnnex Iprovides abasis forAnnex IIandfootnote 61oftheAgreement. Thus, the
negotiating history offootnote 61focuses primarily onthetextofitems (h)and(i)ofAnnex I.
II. NEGOTIATING HISTORY OFFOOTNOTE 61INTHE AGREEMENT ONSUBSIDIES
AND COUNTERVAILING MEASURES
5. Annex IintheAgreement isacounterpart ofAnnex IintheAgreement onInterpretation
andApplication ofArticles VI,XVIandXXIII oftheGeneral Agreement onTariffs andTrade
(hereinafter the"Tokyo Round Subsidies Code"). IntheTokyo Round Subsidies Code, items (h)
and(i)ofAnnex Icontained theterm"goods thatarephysically incorporated intheexported
product" instead of"inputs thatareconsumed intheproduction oftheexported product".
6. Intheinitial phase ofthenegotiations during theUruguay Round, some delegations
expressed aneedtoexamine andclarify theIllustrative Listcontained inAnnex IoftheTokyo
Round Subsidies Code. Forexample, thefollowing statements were made inthisregard:
"Experience hasshown thatthere iscurrently noagreement among Code Signatories onthescope
ofArticle 9,aswellastheroleandeffect ofthe'Illustrative List'associated withArticle 9.
These points should beclarified through thereview"2;and"Clarification ofthescope ofArticle 9
oftheCode regarding export subsidies onproducts other thancertain primary products is
required. Thecontent oftheIllustrative Listshould alsobeclarified".3Achecklist ofissues for
negotiations prepared bytheSecretariat noted that: "There isgrowing doubt insome quarters that
theCode'streatment ofborder taxadjustments (thatis,theassumption thatnon-excessive
remission ofindirect taxes onexported products istrade neutral) reflects thetrueeconomic effect
ofsuchadjustments. Accordingly, theAgreement 'scurrent treatment ofthispractice should be
re-examined".4
7. Anumber ofaspects were considered inthediscussion onsubsidies pertaining toinputs
incorporated intoaproduct traded internationally. Forexample, inthecontext ofnon-actionable
subsidies, theEChadproposed that5:
1Annex IIIprovides "Guidelines intheDetermination ofSubstitution Drawback Systems asExport Subsidies".
2MTN.GNG/NG10/W/1.
3MTN.GNG/NG10/W/8.
4MTN.GNG/NG10/W/9/Rev.2.
5MTN.GNG/NG10/W/7.WT/CTE/W/16
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"(iv) Indirect subsidies:
These aresubsidies given oninputs which aresubsequently incorporated intoa
product traded internationally .Incircumstances where thesubsidy conferred on
theinput product isgenerally available orwhere theinput itself isgenerally
available toawider range ofusers, thedownstream product should beconsidered
nottohavebenefitted from actionable trade-distorting subsidies." (emphasis
added)
8. Thefirstformal proposal thatrebate ofindirect taxes ordrawback ofimport charges on
inputs should notbedeemed asexport subsidies wassubmitted byIndia6.Theproposal wasmade
inthecontext ofadiscussion ofnon-actionable subsidies, andstated that:
"Countervailable subsidies
There isnoconsensus onthecircumstances under which export incentives
andother programmes ofgovernment assistance toenterprises constitute
countervailable subsidies. While financial contribution bygovernment isa
necessary prerequisite, thisshould notimply thatsuchcontribution persemakes
thepractice acountervailable subsidy. Compensatory payments which merely
offset ahandicap should notbecountervailable. Reimbursement ofthedifference
between theinternational price andthedomestic price ofproducts andservices
usedintheproduction ofexported goods isanexample ofsuchcompensatory
payments.
Contribution bygovernment forenabling financial institutions toextend
export credit atratesdifferent from those atwhich credit ismade available for
other purposes, should notbedeemed tobeacountervailable subsidy aslongas
thecredit isgiven atratesequal toorabove theratesprevalent ininternational
capital markets. Onthesame principle, rebate ofprior stage cumulative indirect
taxes should notbetreated ascountervailable subsidy whether ornotsuchtaxes
havebeenlevied ongoods andservices physically incorporated intheexported
product. Article VIofGATT states thatnoproduct canbesubject to
countervailing dutybyreason oftheexemption ofsuchproduct from taxes or
duties borne bythelikeproducts when destined forconsumption inthecountry of
origin. Thisprovision clearly suggests thatrebate oftaxes onauxiliary material
(e.g.energy, fuel,lubricants, packing, stationery), durable capital goods (e.g.
machinery buildings, vehicles) andservices (e.g.transport, advertising) cannot be
treated ascountervailable subsidies. Incentives given toenterprises toenable them
toovercome locational disadvantages should alsobenon-countervailable.
Negotiations should beheldtoarrive atunderstandings inthisregard." (emphasis
added)
9. Discussions onthisissue continued7,andanother formal proposal wasmade inSeptember
1989 bySwitzerland, insupport ofextending thescope ofremission ofindirect taxes toinputs
6MTN.GNG/NG10/W/16.
7Seeforexample, reports ofthemeetings ofthenegotiating group inMTN.GNG/NG10/12 and13,which statethata"number ofquestions
were raised regarding theimplications ofconverting theillustrative listintoadefinitive list,rationale forsingling outproblems relating
toparagraphs (h),(i)and(j)ofthislistandproposed criteria forprohibiting some other subsidies" (MTN.GNG/NG10/12); andthat"some
participants supported theproposal thattherules onindirect taxes andremission ordrawbacks inparagraphs (h)and(i)should apply to
allinputs, andnotonlytothose physically incorporated" (MTN.GNG/NG10/W/13).WT/CTE/W/16
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other thanphysically incorporated intheexported product.8Therelevant partofthisproposal
stated that:
" Item(h)anditem(i):item(h)points outtothequestion oftheexemption,
remission ordeferral ofprior stage cumulative indirect taxes levied ongoods that
arephysically incorporated (making normal allowance forwaste) intheexported
merchandise. Thesame condition appears initem(i)thatrelates totheremission
ordrawback ofimport charges. According totheguidelines onphysical
incorporation (SCM/68, 24October 1985), inputs arephysically incorporated if
theyareusedintheproduction process andarepresent intheproduct exported,
though theyneednotbepresent inthefinalproduct inthesame form inwhich
theyentered theproduction process. Thisclause isnotfullycompatible withthe
notion ofnettransfer offunds because allindirect taxes andimport charges on
services, suchastransportation andcommunication, aswellasonmachinery, and
onfungible inputs suchasfuelandelectricity usedinthemanufacturing process
arenotphysically incorporated inthefinalproduct. Consequently therules on
indirect taxes andremissions ordrawbacks should apply toallinputs." (emphasis
inoriginal)
10. InNovember 1989, India reiterated itsprevious proposal andpresented itingreater
detail9,stating that:
"Anumber ofchanges are,however, necessary intheillustrative listofexport
subsidies contained intheSubsidies Code. Initems (h)and(i)oftheillustrative
list,thetestofphysical incorporation hasbeenstipulated. Rebate ofprior stage
cumulative indirect taxes orimport charges istreated asanexport subsidy ifsuch
taxes orcharges arelevied ongoods orservices which arenotphysically
incorporated intheexported product. Thus, rebate oftaxes onauxiliary materials,
capital goods andservices employed intheproduction ofexported goods falls
under thedefinition ofexport subsidy. Thephysical incorporation testalsoapplies
todrawback orremission ofexport charges levied onimported inputs usedinthe
exported product. Thephysical incorporation testisbadfrom thepoint ofviewof
bothequity andeconomic efficiency. Itplaces atadisadvantage countries with
multi-stage cumulative taxsystems vis-à-vis those withvalue-added taxsystems as
inthelatter, there isnoimpediment totheexporter collecting fullcredit forall
prior stage taxes paidoninputs. Ifglobal efficiency istobepromoted, thensuch
taxes levied notonlyonthefinalproduct andtherawmaterials, butalsothose
levied ontheinputs should beallowed toberebated, astheyalsohaveaprice-
raising effect. Thephysical incorporation testisalsonotconsistent with
Article XI:4ofGATT asitismanifest thatprior stage taxes paidoninputs,
whether ornotphysically incorporated inthefinalproduct, are'borne bythelike
product '."
11. Thediscussion ofthisissue continued, without anyconvergence ofviews. On
4September 1990, theChairman oftheNegotiating Group presented adrafttextofthe
8MTN.GNG/NG10/W/26.
9MTN.GNG/NG10/W/33.WT/CTE/W/16
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Agreement.10Thewording ofitems (h)and(i)ofAnnex Iinthisdrafttextwasthesame asthat
intheTokyo Round Subsidies Code. Annex IIinthedrafttextprovided "Guidelines onPhysical
Incorporation"11,andAnnex IIIprovided "Guidelines intheDetermination ofSubstitution
Drawback Systems asExport Subsidies".12These Annexes remained unchanged inthetextofthe
Agreement submitted inDecember 1990 totheMinisterial Conference heldinBrussels.13
12. In1991, theproposal forchanging "goods thatarephysically incorporated intheexported
product" initems (h)and(i)ofAnnex Iwasconsidered again. Itwasspecifically taken upfor
discussion inOctober 1991 inthecontext ofissues thatwere yettobesettled inthenegotiations
ontheAgreement onSubsidies andCountervailing Measures. Thisdiscussion ledtoanagreement
tochange thetextofitems (h)and(i)ofAnnex I,byinserting "inputs thatareconsumed inthe
production oftheexported product" inplace of"goods thatarephysically incorporated inthe
exported product". Thisresulted incorresponding changes inthetextsofAnnexes IIandIIIof
theAgreement. Footnote 61wasadded toAnnex IIinorder toexplain thecoverage of"inputs
consumed intheprocess ofproduction" thathadbeenagreed inthenegotiations. TheDraft Final
Act,i.e.document MTN.TNC/W/FA (dated 20December 1991), contained thisrevised text.
10MTN/GNG/NG10/W/38/Rev.1.
11TheGuidelines inAnnex IIhadbeenadopted bytheTokyo Round Committee onSubsidies andCountervailing Measures atitsmeeting
of23-24 October 1985. SeeBISD 32S/156.
12TheGuidelines inAnnex IIIhadbeenadopted bytheTokyo Round Committee onSubsidies andCountervailing Measures atitsmeeting
of1November 1984. SeeBISD 31S/257.
13MTN.TNC/W/35/Rev.1.