Case Analysis: India loses Export Subsidy Case in WTO against US

The Author, Rajan Kumar is a Trade Lawyer at YKG & Associates.

Complainant: United Sates

Respondent: India

Third Parties: Brazil, China, Canada, Egypt, European Union, Japan, Kazakhstan, Korea, Republic of Russia Federation, Sri Lanka, Chinese Taipei, Thailand

Brief fact: On 14 March 2018, the United States requested consultations with the Government of India under the WTO Dispute Settlement Mechanism on some of the export promotion programs maintained by India. The US claimed that the following export promotion programs are ‘prohibited subsidies’ within the meaning of Article 3 of the WTO Agreement on Subsidies and Countervailing Measures (“ASCM”):

• The Export Oriented Units (EOU) Scheme and Sector-Specific Schemes, including the Electronics Hardware Technology Parks (EHTP) Scheme and the Bio-Technology Parks (BTP) Scheme (collectively, the EOU/EHTP/BTP Schemes); (A range of entitlements are granted to the EOUs subject to a commitment to export their production of goods and services.)
•  The Merchandise Exports from India Scheme (MEIS);
•  the Export Promotion Capital Goods (EPCG) Scheme;( Capital goods used for exported goods are exempted from customs duties on importation, subject to two export obligations)
•  the Special Economic Zones (SEZ) Scheme; (SEZs are geographical regions which provide for range of benefits to the units set up within the SEZs.)
• the Duty-Free Imports for Exporters Scheme (DFIS). Together these measures, upon fulfilment of stipulated conditions, allow eligible Indian producers to avail of: 
• Exemptions from customs duties on importation of various goods (including capital goods) in case of EPCG, EOU/EHT/BTP, DFIS and SEZ
• Duty credit scrips adjustable against customs duties, central excise duties and certain other charges owed to the Indian Government in case of MEIS
• Exemptions from IGST and deduction of export earnings from corporate income taxes in case of SEZ

The Consultations between United states and India failed to resolve the dispute, due to which United States requested the World Trade Organization Panel to resolve the dispute.The United States alleged that the above export promotion programs are violative and can no longer be maintained by India and immediately required to be withdrawn. The US claimed that in 2016, India has crossed the exemption threshold provided in the Agreement on Subsidy and Countervailing Measures Agreement to developing countries.

Main Legal Provision Involved:  Article 3.1(a)[1], Article 3.2[2] and Article 27 of Agreement on Subsidies and Countervailing Measures

Issue No.1: Whether the subsidies granted under the Export Oriented Units and Sector-Specific Schemes are export contingent?

Argument by Complainant: The United States argued that the exemption from customs duties under the EOU/EHTP/BTP Schemes is export contingent in law. According to the United States, this is because "India conditions the availability" to participating Units of the customs duty exemption under the scheme "upon the [Units'] promise of agreeing to export their entire production and obtaining and maintaining of a positive Non-financial entity". This is "evidenced throughout government documents, including in the provision for penal action if a Unit fails to maintain a positive Non-financial entity[3].

Argument by Respondent:  According to India, the EOU/EHTP/BTP Schemes are "an administrative system that seeks to boost the manufacturing capabilities of [the] domestic industry", and are remission schemes falling under footnote 1 and the Annexes of the SCM Agreement. Regarding the Non-Financial Entity requirement, India argues that it is not indicative of export contingency but ensures that Units act with commercial prudence and without operating at a loss.

Issue No.2: Whether the subsidies granted under the Export Promotion Capital Goods Scheme are export contingent?

Argument by Complainant:  The United States argues that the duty exemption under the EPCG Scheme is contingent in law upon export performance. According to the United States, the scheme requires participating exporters to fulfil two cumulative export obligations and even incentivizes their early fulfilment. Non-compliance with these obligations results in duty liability and sanctions.

Argument by Respondent: India does not respond to the United States' arguments on export contingency and contends that the United States has not established the existence of a subsidy under Article 1 of the SCM Agreement. Rather, in India's view, the scheme falls under footnote 1 and thus does not qualify as a subsidy within the meaning of Article 1.

Issue No.3: Whether the tax exemptions and deductions under the Export Oriented Units and Sector-Specific Schemes, Export Promotion Capital Goods Scheme, Special Economic Zones Scheme, and Duty-Free Imports for Exporters Scheme, confer a benefit?

Argument by Complainant: The United States argues that these exemptions confer a benefit on their recipients, because recipients do not have to pay the duties and taxes they would otherwise have to pay and, therefore, are financially "better off" than in the absence of the financial contribution. The United States asserts that in cases of government revenue foregone, such as these, the benefit resides in the very fact that revenue is forgone.

Argument by Respondent:  India argues that reasoning wrongly the notions of financial contribution and benefit. Relying among others on Canada – Renewable Energy / Canada – Feed-in Tariff Program, India emphasizes the need for "an appropriate understanding of 'the market' … to determine whether a benefit has been conferred". In particular, with regard to the exemptions under the EOU/EHTP/BTP Schemes, EPCG Scheme, and DFIS, India argues that the United States has failed to establish the existence of a benefit because it has not provided "an appropriate analysis or definition of the market.

Issue No. 4: Whether the subsidies granted under the Special Economic Zones Scheme are export contingent?

Argument by Complainant:   The United States argues that the challenged subsidies under the SEZ Scheme are contingent on export performance, in law or in fact. In particular, first, to qualify as SEZ Units, applicants must undertake to meet a positive NFE requirement, and this requirement is then subject to monitoring and "penal action" in case of non-compliance. Second, SEZ Units are required to "export the goods manufactured". Third, one of the subsidies, i.e. the deduction from total income for purposes of corporate income tax, is reserved to "export" income. In addition, in the context of its argument that the subsidies under the SEZ Scheme are also export contingent in fact, the United States relies on the preamble of the SEZ Act, the description of the functions of the competent agencies in the SEZ Act, and public statements of government officials, all to the effect that the purpose of the SEZ Scheme is the promotion of exports.

Argument by Respondent:  India disagrees with the United States and argues that the SEZ Scheme is not export-contingent, in law or fact. According to India, the United States has mischaracterized the obligation to achieve a positive NFE, because SEZ Units can fulfil that requirement through domestic transactions, without making any export sales. Moreover, India disagrees with how the United States has portrayed, and relied upon, the application, approval and monitoring process for SEZ Units. Further, India submits that the United States failed to apply the correct legal test for de jure contingency. With regard to de facto contingency, India argues in particular that the United States erred in giving probative value to statements of government officials and in relying on the same type of evidence relied upon to prove de jure contingency.

Issue No.5 Whether the subsidies granted under the Duty-Free Imports for Exporters Scheme are export contingent?

Arguments by Complainant:  The United States argues that the DFIS exemptions from customs duties are contingent in law upon export performance. According to the United States, under DFIS, participating exporters must have made exports in the previous year to obtain the exemptions, and the value of these past exports determines the amount of the duty-free entitlement.

Arguments by Respondent: India mostly does not respond to the United States' arguments on export contingency and contends that the United States has not established the existence of a subsidy under Article 1 of the SCM Agreement.

Issue No.6: Whether the subsidies granted under the Merchandise Exports from India Scheme are export contingent?

Arguments by Complainant:  The United States argues that MEIS scrips are contingent upon export performance.798 Specifically, citing the Foreign Trade Policy, the United States argues that under MEIS, a "program participant receives scrips conditioned and tied to the value it exports, where the exports are sold, and of what product".799 According to the United States, "[f]rom approval to award to monitoring, the amount of scrips hinges on export performance".

Arguments by Respondent:  India does not respond to the United States' arguments on export contingency and submits that the question of export contingency is moot because MEIS falls under footnote 1 and Annexes I(g) and I(h).

Panel decisions

a. the exemptions from customs duties on importation under the EOU/EHTP/BTP Schemes are subsidies contingent upon export performance, inconsistent with Articles 3.1(a) and 3.2 of the SCM Agreement;

1. 2. the exemptions from customs duties on importation under the EPCG Scheme are subsidies contingent upon export performance, inconsistent with Articles 3.1(a) and 3.2 of the SCM Agreement;

c. the exemptions from customs duties on importation and exportation, the exemption from IGST on importation, and the deductions from taxable income, all provided under the SEZ Scheme, are subsidies contingent upon export performance, inconsistent with Articles 3.1(a) and 3.2 of the SCM Agreement;

1. 4. the exemptions from customs duties on importation under Conditions 10, 21, 36, 60(ii) and 61 of DFIS are subsidies contingent upon export performance, inconsistent with Articles 3.1(a) and 3.2 of the SCM Agreement; and
   5. the duty credit scrips awarded under MEIS are subsidies contingent upon export performance, inconsistent with Articles 3.1(a) and 3.2 of the SCM Agreement.

Also Note Below.

The ‘prohibited subsidies’ i.e. subsidies which are not allowed to be granted or maintained by WTO member countries[4]. Subsidies contingent, in law or in fact, upon export performance are considered as prohibited subsidies as per paragraph 1(a) of Article 3 of ASCM. However, Article 27 of the ASCM provides for ‘special and differential treatment’ towards developing countries, which states that:

“27.2 The prohibition of paragraph 1(a) of Article 3 shall not apply to:

• developing country Members referred to in Annex VII.
• other developing country Members for a period of eight years from the date of entry into force of the WTO Agreement, subject to compliance with the provisions in paragraph 4.”

Annex VII provided that several developing countries including India can maintain export contingent subsidy programs provided that their per capita income did not cross $1000 mark in current dollars and did not reach $1,000 in constant 1990 dollars for three consecutive years. Paragraph 2(b) of Article 27 would be applicable to these developing countries including India when they cross these thresholds.

It was not disputed that India crossed these thresholds in 2016 and had graduated under Annex VII and Article 27 of the ASCM starting from the year 2017.

India argued before the Panel that export promotion programs are not subsidies under Article 1 of the ASCM and even if these export promotion programs are considered as prohibited subsidies, India was entitled to the eight-year period mentioned in paragraph 2(b) of Article 27 starting from the time it graduated. India contended that the Panel should keep in mind the context, object and purpose of the ASCM while interpreting Article 27.2(b).

Thus, the Panel was required to decide:

• Whether the export promotion programs maintained by Government of India are prohibited subsidies within the meaning of paragraph 1(a) of Article 3 of the ASCM.
• What is the time period available to India to withdraw these subsidy programs.

Prohibited subsidy under Article 3 of the ASCM

The footnote 1 provides that an exemption or remission of duties or taxes on an exported product not in excess of the duties and taxes which have accrued shall not be deemed to be a subsidy. The footnote 1 must also be read with Annexes I to III of the ASCM, which provides further guidelines regarding permissible export promotion programs. India argued that the export promotion programs under challenge do not qualify as subsidies at all in accordance with footnote 1 of the ASCM.

On analysis of the export promotion programs, the Panel found that except with regard to the exemption from central excise duty under EOU Scheme and certain categories of exemptions under DFIS, the rest of the challenged programs were not protected by the permissible criteria laid down under footnote 1 of the ASCM. Consequently, the export promotion programs were considered as subsidies within the meaning of Article 1.1(a) of the ASCM.

The Panel held that the challenged subsidies were contingent in law upon export performance because the subsidy programs expressly required export obligation as the criterion for availing the tax benefit. Thus, the Panel observed that the export promotion programs were therefore prohibited within the meaning of Article 3 of the ASCM.

Time period under Article 27 of ASCM

The Panel disagreed with India’s argument that the eight-year period in Article 27.2(b) of the ASCM starts from the day of graduation from Annex VII. The Panel concluded that the eight-year transition period from the date of entry into force of the WTO Agreement had expired on 1 January 2003, including for Members graduating from Annex VII(b).

The Panel, considering the administrative and legal mechanism required to implement the withdrawal of different programs, gave different time period for the withdrawal of each subsidy program from the day of adoption of Panel Report.

Conclusion

The panel report has wide reaching effect on the Indian export sector and has generated serious concerns amongst Indian exporters who are using these export promotion programs to gain competitive advantage. India has filed an appeal on 19th November 2019 and therefore the Panel Report has not been adopted, thus providing India some additional time for withdrawing the challenged schemes. It may also be noted that India will also gain additional time from the critical circumstances facing the WTO Appellate Body. For the first time since the advent of WTO, the Appellate Body may become effectively dysfunctional. It may run out of its minimum quorum of three members on 11th December 2019, when two of the three existing Appellate Body Member retire on 10th December 2019. Interestingly, the crisis in the Appellate Body is attributable to the US as it is the US that has repeatedly blocked the selection process for filling vacancies at the WTO’s Appellate Body.

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