WTO Appellate Body Report: US – Conditional Tax Incentives for Large Civil Aircraft

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SUMMARY:

Decision:

The WTO Appellate Body has ruled that certain tax incentives provided by the State of Washington in the aerospace sector are not prohibited import substitution subsidies under the Agreement on Subsidies and Countervailing Measures (SCM Agreement). The Appellate Body rejected the appeal by the European Union on these issues, while upholding a cross-appeal by the United States.

This is one of a series of reports on WTO Panel or Appellate Body decisions.

Significance of Decision:

This decision is the latest but by no means the final iteration in the longstanding aircraft subsidy dispute between Boeing and Airbus.

The main issue in the current appeal related to certain tax breaks granted by the State of Washington for aircraft production, estimated by the EU to be worth several billion dollars. This case focused on so-called "siting" provisions. One set of tax incentives was available "upon the siting of a significant commercial airplane manufacturing program" in Washington State, a condition met by Boeing's 777X aircraft program. The other siting provision stated that certain incentives would no longer apply if any final assembly or wing assembly of a commercial airplane was "sited outside of Washington". The EU argued that the siting provisions were prohibited import substitution subsidies, i.e., subsidies contingent upon the use of domestic over imported goods.

The Appellate Body disagreed, reasoning that in order to establish a violation of the prohibited import substitution subsidy disciplines of the SCM Agreement, it was necessary to demonstrate a condition requiring the use of domestic over imported goods. The Appellate Body found no such requirement in the Washington State laws. It stressed that the prohibited subsidies rules do "not prohibit the subsidization of domestic 'production' per se but rather the granting of subsidies contingent upon the 'use', by the subsidy recipient, of domestic over imported goods". It added that even if Boeing would "likely" use some domestically produced wings and fuselages, this was insufficient to establish the existence of a condition requiring the use of domestic over imported goods.

The Appellate Body's decision thus hinged on the meaning of contingency, i.e., when a subsidy will be considered to be "contingent" on the use of domestic over imported goods. Consistent with its prior rulings, the Appellate Body interpreted "contingent" to mean a condition or a requirement for receiving the subsidy. As it found that no such condition existed under the Washington State measures, it ruled in favour of the United States on all issues.

In a related case (DS353), the EU has established that a Washington State tax incentive has caused "serious prejudice" to the EU, and thus – even if not prohibited – is an actionable subsidy under SCM Agreement. This dispute has now reached the Appellate Body as a compliance matter and will subject to a separate ruling.

REPORT:

Background: Washington State tax incentives

In this dispute, the EU challenged certain tax-related measures provided by Washington State:

  • a reduction in the business and occupation ("B&O") tax rate that applies to business activities involved in the manufacture and sale of commercial airplanes (the "B&O aerospace tax rate"); and
  • a series of other tax credits or exemptions (the "aerospace tax measures").

The EU pointed to two "siting" provisions in the Washington State law that governed the availability of the incentives. The "First Siting Provision", which pertained to all of the aerospace tax measures, stated that the tax incentives would take effect "upon the siting of a significant commercial airplane manufacturing program" in Washington. The disputing parties agreed that the First Siting Provision had been fulfilled by Boeing's 777X aircraft program, and that "the challenged tax incentives are therefore in effect". The "Second Siting Provision" concerned the continued availability of the B&O aerospace tax rate, providing that the reduced tax rate would no longer apply if there were a determination by the State of Washington that any final assembly or wing assembly of a commercial airplane under the First Siting Provision "has been sited outside of Washington".

The EU argued that these measures constituted prohibited import substitution subsidies. In the EU view, these measures were in breach of Article 3.1(b) of the SCM Agreement as "subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods".

In November 2016, a WTO Panel dismissed the claim that the aerospace tax measures were de jure contingent (i.e., contingent in law) on the use of domestic over imported goods, a ruling challenged on appeal by the EU. The Panel upheld the EU claim that the B&O aerospace tax rate for the manufacturing or sale of commercial airplanes under Boeing's 777X program was de facto contingent upon the use of domestic over imported goods. This latter ruling was the subject of a cross-appeal by the United States.

Prohibited import substitution subsidies under the SCM Agreement

Article 3.1 of the SCM Agreement prohibits two types of subsidies: export-contingent subsidies, which were not at issue in this case, and import substitution subsidies. Article 3.2 adds that a WTO Member "shall neither grant nor maintain" either type of prohibited subsidy.

In the current dispute, the Appellate Body noted that a subsidy would be "contingent" on the use of domestic over imported goods "if the use of those goods were a condition, in the sense of a requirement, for receiving the subsidy". It also recalled its earlier rulings that "the legal standard expressed by the term 'contingent' is the same for de jure and de facto contingency". [Original emphasis for this and all italicized quotes below.] It stated that a subsidy will be de jure contingent upon the use of domestic over imported goods "when the existence of that condition can be demonstrated on the basis of the very words of the relevant legislation, regulation or other legal instrument constituting the measure", or can "be derived by necessary implication from the words actually used in the measure". By contrast, the existence of de facto contingency "must be inferred from the total configuration of the facts constituting and surrounding the granting of the subsidy, none of which on its own is likely to be decisive in any given case".

The Appellate Body found that Article 3.1(b) prohibits "the use of domestic goods in preference to, or instead of, imported goods as a condition for receiving the subsidy". It stressed that "by its terms, Article 3.1(b) does not prohibit the subsidization of domestic 'production' per se but rather the granting of subsidies contingent upon the 'use', by the subsidy recipient, of domestic over imported goods". It added that "[s]ubsidies that relate to domestic production are therefore not, for that reason alone, prohibited under Article 3 of the SCM Agreement".

EU appeals dismissed: Washington State "siting" provisions did not require the use of domestic goods

The European Union argued that, in its de jure assessment of the First and Second Siting Provisions, the Panel erroneously confined the applicability of Article 3.1(b) "to those situations where the subsidy recipient is required under the terms of the subsidy measure, for a given good, to use domestic goods to the complete exclusion of imported goods". It similarly argued that "the error in the Panel's interpretation of Article 3.1(b) in the context of its de jure assessment carries over to its de facto assessment of the First Siting Provision".

The Appellate Body dismissed these arguments. It ruled that "the Panel did not articulate a legal standard under Article 3.1(b) of the SCM Agreement requiring the use of domestic goods to the complete exclusion of imported goods". Instead, the Panel found that the First and Second Siting Provisions "relate to the location of certain assembly operations within Washington and are silent as to the use of domestic or imported goods".

The EU also argued that the Panel erred in its application of Article 3.1(b) by finding that the First Siting Provision does not make the aerospace tax measures de jure contingent upon the use of domestic over imported goods.

The Appellate Body rejected this argument. It reasoned that "the relevant question in determining the existence of de jure contingency under Article 3.1(b) is not whether the production requirements… may result in the use of more domestic and fewer imported goods, but whether the measure, by its terms or by necessary implication therefrom, sets out a condition requiring the use of domestic over imported goods". It followed, according to the Appellate Body, that "even if… Boeing would likely use some amount of domestically produced wings and fuselages, this observation is not in itself sufficient to establish the existence of a condition, reflected in the measure's terms or arising by necessary implication therefrom, requiring the use of domestic over imported goods".

The Appellate Body similarly dismissed the EU claim that the Panel had failed to make an "objective assessment" of the matter under Article 11 of the Dispute Settlement Understanding.

U.S. cross appeal allowed: de facto contingency not established

The U.S. argued in its cross-appeal that the Panel erred in finding that the B&O aerospace tax rate was de facto contingent upon the use of domestic over imported goods. The Appellate Body upheld this U.S. claim.

The Appellate Body noted that "it is the location of production, not the imported or domestic origin of the resulting product, that would trigger the loss of the B&O aerospace tax rate". The Appellate Body "consider[ed] it significant that the Second Siting Provision is focused on the 'siting' of assembly activities". It reiterated that "although conditions for eligibility and access to a subsidy may entail certain consequences for a domestic producer's sourcing decisions between domestic and imported goods, this alone does not equate to a condition requiring the use of domestic over imported goods".

The Appellate Body found that the Panel failed to establish that the Second Siting Provision, "in addition to the conditions relating to the siting of production activities, also entails a condition requiring the use of domestic over imported goods". It concluded that "we do not consider that the Panel's analysis and reasoning provided a sufficient basis for its finding that the Second Siting Provision makes the B&O aerospace tax rate de facto contingent upon the use of domestic over imported goods within the meaning of Article 3.1(b) of the SCM Agreement". It reversed the Panel's finding that the U.S. had acted inconsistently with Articles 3.1(b) and 3.2 of the SCM Agreement.

The Appellate Body thus found that the challenged Washington State tax measures were consistent with the import substitution subsidy disciplines of the SCM Agreement.

The Report of the WTO Appellate Body in United States – Conditional Tax Incentives for Large Civil Aircraft (DS487) was circulated on 4 September 2017.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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