Subsidies

Subsidies and other measures can be used for protectionist purposes in international trade. Rules
on subsidies are set out in Articles XVI and VI of the GATT. It provided weak multilateral
disciplines and authorized GATT Contracting Parties to take domestic action against injurious
subsidies in the form of countervailing duties.The Agreement on Subsidies and Countervailing
Measures (the ‘SCM Agreement’) contains the primary rules on the use of subsidies and
countervailing duties and it was the part of the Tokyo round.

Regulating subsidies is more difficult than regulating tariffs.A ‘subsidy’ is a payment by a

government to a firm or household that provides or consumes a commodity. For example,
governments often subsidize food by paying for part of the food expenditures of low-income
households. Based on this definition and the accompanying example, it is clear that there are
subsidies that have little effect on trade and promote policies that are widely considered to be
desirable.

There were two key aspects of subsidies. Firstly, what kinds of government actions constitute
‘subsidies’? Secondly, which of these subsidies had tradedistorting effects? Subsidy is a
government payment to a private entity. In this form, subsidies are fairly easy to identify and
regulate. For example, where a government gives money to a specific private company with no
expectation of repayment, it is clear that this would constitute a subsidy. However, subsidies
could be provided in various other ways. Furthermore, not all direct payments have trade-
distorting effects that cause concern. Thus, in order to establish an appropriate trade regulation
framework for subsidies, the key questions are: what are subsidies and when should they be
prohibited? We will discuss and review the provisions of the SCM Agreement that address these
questions. In addition to the SCM Agreement rules, we will also discuss various other provisions
of the WTO Agreement that address subsidies in a narrower and more limited way.

The provisions of subsidies seek to find the right balance between allowing subsidies for
legitimate policy goals, and restricting their use when the trade-distorting effects become too
great.First, we will review the rules that identify which subsidies are subject to the SCM
Agreement. The Agreement defines the term subsidy to limit its regulation to the forms of
government assistance set out therein. Only those subsidies defined in the Agreement are subject
to such rules. It limits regulation to subsidies that are ‘specific’ to certain entities, thus excluding
general government programmes such as aid for the poor. Then, we will examine three subsidy
categories established by the SCM Agreement: (1) prohibited subsidies; (2) actionable subsidies;
and (3) non-actionable subsidies.

We will also discuss the role of special remedies available for prohibited and actionable
subsides. In addition, we examine the relationship of the SCM Agreement to provisions on
subsidies in various other agreements, namely the Agriculture Agreement, the GATT and the
TRIMs Agreement. Finally, we examine SCM Agreement rules regulating the ability of
governments to impose countervailing duties on foreign goods pursuant to domestic law. As a
final point at the outset, it is worth noting briefly a number of institutional and other provisions
in the SCM Agreement. Article 24 establishes a Committee on Subsidies and Countervailing
Measures, composed of representatives from each of the Members, which is to carry out
responsibilities as assigned to it under the Agreement. The Committee established a Permanent
Group of Experts composed of five independent persons, highly qualified in the fields of
subsidies and trade relations, who may be requested to assist certain dispute settlement panels.
Articles 25 and 26 then provide for a notification procedure, under which ‘Members shall notify
any subsidy as defined in paragraph 1 of Article 1, which is specific within the meaning of
Article 2, granted or maintained within their territories’. Special, less stringent rules are also
established for certain countries under Article 27 (developing countries) and Article 29
(‘Members in the process of transformation from a centrally-planned into a market, free-
enterprise economy’).

Definition of ‘Subsidy’: A standard economics definition of ‘subsidy’ involves the notion of

payments by a government to a private entity. However, subsidies can be offered through other
means as well. The SCM Agreement recognizes this, and sets out the following rules for
identifying subsidies. Article 1.1 states that a subsidy shall be ‘deemed to exist’ if two conditions
are met. First, there must either be ‘a financial contribution by a government or any public body’
or ‘any form of income or price support’. Secondly, a ‘benefit’ must ‘thereby’ (ie, by the
financial contribution or the income/price support) be ‘conferred’. It is important to emphasise
that the existence of a financial contribution or price/income support alone is not sufficient to
constitute a subsidy. Rather, the financial contribution or price/income support must also confer
a benefit. We now look closely at the following three elements: (i) government of public body;
(ii) financial contribution; and (iii) benefit.

(i) Government or Public Body: In many contexts under WTO rules, the issue of the nature of the
government’s involvement arises. For example, does the impact on trade result from actions by
the government or actions by private parties? Or, is the entity at issue part of the government or
not? Under the SCM Agreement, this issue comes up in relation to the requirement that financial
contribution comes from ‘a government or any public body’. In the US—Anti-Dumping and
Countervailing Duties (China) case, the Appellate Body considered the meaning of ‘public
body’. ‘A public body within the meaning of Article 1.1.(a)(1) of the SCM Agreement must be
an entity that possesses, exercises or is vested with governmental authority’; however, ‘just as no
two governments are exactly alike, the precise contours and characteristics of a public body are
bound to differ from entity to entity, State to State, and case to case’; ‘Panels or investigating
authorities confronted with the question of whether conduct falling within the scope of Article
1.1.(a)(1) is that of a public body will be in a position to answer that question only by conducting
a proper evaluation of the core features of the entity concerned, and its relationship with
government in the narrow sense’. In this regard, it added that while this determination may be
straightforward when a statute or other legal instrument expressly vests authority in the entity
concerned, such a determination may be more complex in other cases where the picture is ‘more
mixed’. For example, it explained that it does not ‘consider that the absence of an express
statutory delegation of authority necessarily precludes a determination that a particular entity is a
public body’. Rather, ‘[w]hat matters is whether an entity is vested with authority to exercise
governmental functions, rather than how that is achieved’.Thus, the Appellate Body rejected the
panel’s view that a public body is ‘any entity controlled by a government’, and instead focused
on whether the entity possesses, exercises or is vested with governmental authority.

(ii) Financial Contribution: The ‘financial contribution’ element is elaborated upon in Article
1.1(a)(1) through four categories. Under this provision, there will be a financial contribution by a
government or any public body where: (i) There is a government practice involving a direct
transfer of funds (eg grants, loans, and equity infusion) or a potential direct transfer of funds or
liabilities (eg loan guarantees). (ii) Government revenue that is otherwise due is foregone or not
collected (eg fiscal incentives such as tax credits). (iii) A government provides goods or services
other than general infrastructure, or purchases goods. (iv) A government makes payments to a
funding mechanism, or entrusts or directs a private body to carry out one or more of the type of
functions illustrated in (i) to (iii) above which would normally be vested in the government, and
the practice, in no real sense, differs from practices normally followed by governments.

We examine each of these four categories in more detail, setting out the relevant case law where
it is helpful to understand the provision.

a. Direct and Potential Direct Transfers of Funds: The first type of financial contribution is fairly
easy to understand. Whenever money is transferred from the government to a private company,
there will be a financial contribution. The agreement identifies ‘grants, loans and equity infusion’
as examples. In addition, when the government promises to transfer money under certain
conditions, this transfer is considered ‘potential’ and also constitutes a financial contribution.
The agreement identifies ‘loan guarantees’ as an example.

b. Foregone or Uncollected Revenue that is Otherwise Due: The second type of financial
contribution is more complicated. The example given in the text of the Agreement is a ‘fiscal
incentive’ such as a ‘tax credit’. So, for example, if there is a US$500 rebate given on income
taxes for every purchase of a domestic car, this would qualify as a financial contribution under
the second type. Under the terms of the provision, this US$500 is revenue that is ‘otherwise due’,
in the sense that it would be due in the absence of a purchase of a domestic car, but has been
‘foregone’ by the government because the car purchase was made. Similarly, taking an example
from the case law, an exemption from customs duties would also be covered. In Canada —
Autos, the Appellate Body examined a duty exemption that was intended to assist the domestic
industry. This duty exemption was given to companies who used a designated amount of
domestic value added and met certain other requirements.The current tax or customs regime has
a ‘defined, normative benchmark’, and this benchmark is not applied in specific circumstances,
in a manner that collects less revenue, government revenue that is otherwise due has been
foregone.

c. Government Purchase of Goods or Provision of Goods and Services: The third type of
financial contribution is straightforward. Where a government purchases goods, it will generally
do so with a transfer of funds. This situation is similar to, and perhaps overlapping with, the first
type, which covers a ‘direct transfer of funds’. For example, the government may buy military
aircraft built by private companies. In addition, a government’s provision of goods or services
other than general infrastructure, such as roads, is also covered. An example from the case law is
that certain Canadian provinces provided standing timber to timber harvesters, to be processed
into lumber.

d. Payments to Funding Mechanism/Entrustment or Direction of a Private Body Finally, the last

type of financial contribution is where a government involves private entities in the provision of
one of the above types of financial contributions. The government may either make payments to
a ‘funding mechanism’, which then distributes the money, or it may ‘entrust or direct’ a private
body to carry out one of the three listed types.

(iii) Income or Price Support: As an alternative to a financial contribution, a subsidy may also
involve ‘any form of income or price support in the sense of’ Article XVI of the GATT. Article
XVI does not define the terms ‘income support’ and ‘price support’, but rather limits the covered
support to that ‘which operates directly or indirectly to increase exports of any product from, or
to reduce imports of any product into, [a Member’s] territory’. Generally speaking, income and
price support are used in the context of agricultural products, and serve to guarantee farmers’
incomes at a certain level through government payments, or to support prices of products at a
certain level through government guarantees to buy the product if the price should fall below that
level. (iv) Benefit As emphasised above, the existence of a financial contribution or income/price
support is not sufficient for there to be a subsidy. Rather, the financial contribution or
income/price support must confer a benefit. The Appellate Body has spoken fairly clearly on this
issue, explaining that determination of whether a ‘benefit’ exists implies some kind of
comparison, and that the ‘marketplace’ provides an appropriate basis for comparison. For
instance, in Canada—Aircraft it stated: ‘the marketplace provides an appropriate basis for
comparison in determining whether a “benefit” has been “conferred”, because the trade-
distorting potential of a “financial contribution” can be identified by determining whether the
recipient has received a “financial contribution” on terms more favourable than those available to
the recipient in the market’. This principle applies to the different types of financial contributions
in different ways. For example, for the first type of financial contribution, a direct or potential
direct transfer of funds, if the government offers a loan at a 6 per cent interest rate, whereas
private banks are offering 7 per cent, a benefit has likely been conferred. This conclusion
depends, of course, on a comparison of the other terms of the loan (such as any fees, repayment
period, etc) to market benchmarks as well. In practice, the interest rate is only one of many 7 8 9
10 terms relevant to a loan, so a determination will not always be this straightforward, but the
basic concept is fairly clear. Similarly, for equity infusions, the terms of the transaction must be
compared to what could have been obtained in the market. With grants, on the other hand, it can
probably be assumed that there is a benefit, as these are not available in the market. For the
second type of financial contribution, the foregoing of tax revenue that is otherwise due, the
analysis would be similar to that for grants, as tax breaks of this sort are not available in the
market. Finally, in respect of the third type of financial contribution, government purchase of
goods or provision of goods and services, the analysis would be similar to that for loans, as the
purchase price or terms of provision would be compared to what is available in the market. Once
the existence of a financial contribution or income/price support along with the conferment of a
benefit have been established, a subsidy is deemed to exist. However, only subsidies that are
‘specific’ are subject to regulation by the SCM Agreement. We now turn to a discussion of the
concept of specificity.

(b) Specificity Article 1.2 of the SCM Agreement provides that subsidies are ‘subject to’ the
rules on prohibited and actionable subsidies, as well as the rules on countervailing duties, only if
they are ‘specific’, as defined in Article 2. Thus, subsidies that are not ‘specific’ are not
regulated as either prohibited or actionable and also cannot be countervailed. The main point of
the specificity requirement is to exclude broadly based general welfare programmes, such as aid
to the poor, from regulation. Presumably, this exclusion is made for two reasons. First, such
programmes are much less likely to have trade-distorting effects, as it is subsidies to individual
companies or industries that would most effectively favour domestic companies over their
foreign competitors. Secondly, even though broadly based subsidies may in some instances have
negative trade effects, they are nonetheless considered necessary to promote legitimate policy
goals. Article 2 of the SCM Agreement sets out the rules for when specificity exists. As
explained there, the existence of specificity will be based on the following ‘principles’. First,
under the introductory clause to Article 2.1(a), specificity will exist where the granting authority
or relevant legislation explicitly limits access to a subsidy to ‘an enterprise or industry or group
of enterprises or industries’.
Secondly, Article 2.1(b) then establishes that specificity will not be found in certain
circumstances: where a measure ‘establishes objective criteria or conditions governing the
eligibility for, and the amount of, a subsidy’, there will be no specificity ‘provided that the
eligibility is automatic and that such criteria and conditions are strictly adhered to’. Article 2.1(c)
then provides, ‘[i]f, notwithstanding any appearance of non-specificity resulting from the
application of the principles laid down in subparagraphs (a) and (b), there are reasons to believe
that the subsidy may in fact be specific, other factors may be considered’. It then sets out the
following factors for the consideration of whether a subsidy is specific: ‘use of a subsidy
programme by a limited number of certain enterprises, predominant use by certain enterprises,
the granting of disproportionately large amounts of subsidy to certain enterprises, and the manner
in which discretion has been exercised by the granting authority in the decision to grant a
subsidy’.

III. REGULATION OF SPECIFIC SUBSIDIES UNDER THE SCM AGREEMENT: The

previous section explained that only certain forms of government assistance—those that meet the
definition of ‘subsidy’ and are ‘specific’—are regulated under the SCM Agreement. In this
section, we discuss how the SCM Agreement rules apply to the covered subsidies. There are
three components to this regulation:

a) rules on prohibited subsidies;

b) rules on actionable subsidies; and
c) rules on non-actionable subsidies.
This regulatory structure has been referred to as the ‘traffic light’ system: ‘prohibited subsidies’
are never allowed, and are thus faced with a red light; ‘actionable subsidies’ are permitted as
long as they do not have ‘adverse’ trade effects, and are therefore faced with a yellow or amber
light (depending on your particular country’s traffic signal colours); and non-actionable
subsidies, the provisions of which have since lapsed but were permitted in the early years of the
WTO, faced a green light.

(a) Prohibited Subsidies: Part II of the SCM Agreement addresses so-called ‘prohibited
subsidies’. ‘Prohibitedsubsidies’ are just like they sound: banned in all cases. Article 3 of the
SCM Agreement sets out two kinds of prohibited subsidies: export subsidies and domestic
content subsidies. Article 3.2 provides that Members ‘shall neither grant nor maintain’ these
subsidies. As elaborated in the concluding part of this section, these two kinds of subsidies are
singled out for harsher treatment under the rules because of their strongly trade-distorting effects.
All subsidies have the potential to have such effects, but these two have effects that are
considered particularly egregious. Export subsidies can harm foreign competitors in markets
around the world; and domestic content subsidies limit foreign companies’ access to a Member’s
domestic market.

(i) Export Subsidies: Article 3.1(a) of the SCM Agreement addresses export subsidies. In
particular, it prohibits ‘subsidies contingent, in law or in fact, whether solely or as one of several
other conditions, upon export performance, ‘[t]his standard is met when the facts demonstrate
that the granting of a subsidy, without having been made legally contingent upon export
performance, is in fact tied to actual or anticipated exportation or export earnings’. ‘[t]he mere
fact that a subsidy is granted to enterprises which export shall not for that reason alone be
considered to be an export subsidy within the meaning of this provision’. Thus, while these
subsidies are commonly referred to by the shorthand name ‘export subsidies’, a more precise
description of the subsidies at issue is provided in the Agreement, focusing on the concept of
export ‘contingency’. This ‘contingency’ requires some degree of link or relationship between
export and the subsidy.

(ii) Domestic Content Subsidies: Article 3.1(b) of the SCM Agreement addresses domestic
content subsides (sometimes called ‘local content’ or ‘import substitution’ subsidies).
Specifically, it prohibits ‘subsidies contingent, whether solely or as one of several other
conditions, upon the use of domestic over imported goods’.

(iii) Prohibited Subsidies: Final Thoughts: there is a distinction between two types of subsidy
measures, which can be particularly important in the case of Prohibited Subsidies: subsidy
programmes versus one-time subsidies. A subsidy programme is a regime established by a
government to provide subsidies under certain conditions over time. By contrast, a one-time
subsidy is a single, independent subsidy given by a government.

(b) Actionable Subsidies Part III of the SCM Agreement addresses actionable subsidies. In
essence, the use of the term ‘actionable’ means that under this provision subsidies are not
prohibited outright, as with prohibited subsidies, but rather an action may be brought challenging
such subsides as having certain negative trade effects. Where the existence of such effects is
shown, the subsidies violate the SCM Agreement. The trade effects in question are set out in
Article 5, which refers to subsidies that cause ‘adverse effects 26 27 28 29 to the interests of
other Members’. This provision refers to three types of ‘adverse effects’: (a) injury to the
domestic industry of another Member; (b) nullification or impairment of benefits accruing
directly or indirectly to other Members under GATT, in particular the benefits of concessions
bound under GATT Article II; (c) serious prejudice to the interests of another Member.

Article 6.3 then explains that ‘serious prejudice’ ‘may arise in any case where one or several of
the following apply’: (a) the effect of the subsidy is to displace or impede the imports of a like
product of another Member into the market of the subsidising Member; (b) the effect of the
subsidy is to displace or impede the exports of a like product of another Member from a third
country market; (c) the effect of the subsidy is a significant price undercutting by the subsidised
product as compared with the price of a like product of another Member in the same market or
significant price suppression, price depression or lost sales in the same market; (d) the effect of
the subsidy is an increase in the world market share of the subsidising Member in a particular
subsidised primary product or commodity as compared to the average share it had during the
previous period of three years, and this increase follows a consistent trend over a period when
subsidies have been granted. Thus, if a panel concludes that any of these four scenarios is met,
this provides a sufficient basis for finding serious prejudice.

(c) Non-actionable Subsidies Part IV of the SCM Agreement addresses non-actionable subsidies.
These provisions are no longer in force. Article 8.2 sets out the following types of subsidies that
are ‘non-actionable’: • Paragraph (a): Research and Development (‘assistance for research
activities conducted by firms or by higher education or research establishments on a contract
basis with firms’ where certain conditions are met.) • Paragraph (b): Regional Development
(‘assistance to disadvantaged regions within the territory of a Member given pursuant to a
general framework of regional development and non-specific (within the meaning of Article 2)
within eligible regions’ where certain conditions are met.) • Paragraph (c): Environmental
Protection (‘assistance to promote adaptation of existing facilities to new environmental
requirements imposed by law and/or regulations which result in greater constraints and financial
burden on firms’.) The elimination of the ‘non-actionable’ category of subsidies does not mean
that these policies cannot be pursued. Rather, it simply means that when providing these kinds of
subsidies, governments must be careful to do so in a way that does not lead to the subsidies
falling into the ‘prohibited’ category, or having a trade impact that would constitute ‘adverse
effects’ or lead to injurious imports that may be countervailed.