CANADA – MEASURES AFFECTING THE IMPORTATION OF MILK AND THE EXPORTATION OF DAIRY PRODUCTS SECOND RECOURSE TO ARTICLE 21.5 OF THE DSU BY NEW ZEALAND AND THE UNITED STATES AB-2002-6
Document: AB-2002-6 Report of the Appellate Body
Date: 20 December 2002
Document codes: WT/DS103/AB/RW2; WT/DS113/AB/RW2
Complainant: New Zealand
Respondent: Canada
Third parties: Argentina, Australia, EU, Japan, Mexico, U.S.
Dispute stage: Mutually Agreed Solution
Agreements cited: Art. 3, 8, 9, 10  AgricultureArt. X:1  GATT 1994

CANADA – MEASURES AFFECTING THE IMPORTATION OF MILK
AND THE EXPORTATION OF DAIRY PRODUCTS
SECOND RECOURSE TO ARTICLE 21.5 OF THE DSU
BY NEW ZEALAND AND THE UNITED STATES
AB-2002-6
Report of the Appellate Body

APPELLATE BODY
Canada – Measures Affecting the Importation of
Milk and the Exportation of Dairy Products
Second Recourse to Article 21.5 of the DSU
by New Zealand and the United States
Canada, Appellant
New Zealand, Appellee
United States, Appellee
Argentina, Third Participant
Australia, Third Participant
European Communities, Third Participant
AB-2002-6
Present:
Baptista, Presiding Member
Sacerdoti, Member
Taniguchi, Member
I. Introduction
1. Canada appeals certain issues of law and legal interpretations in the Panel Report,
Canada – Measures Affecting the Importation of Milk and the Exportation of Dairy Products – Second
Recourse to Article 21.5 of the DSU by New Zealand and the United States (the "Panel Report"). 1 The
Panel was established to consider a complaint by New Zealand and the United States that certain
measures taken by Canada to comply with the recommendations and rulings of the Dispute Settlement
Body (the "DSB") in Canada – Dairy 2 are not consistent with Canada's obligations under the
Agreement on Agriculture and the Agreement on Subsidies and Countervailing Measures (the
"SCM Agreement ").
2. In Canada – Dairy, the original panel and the Appellate Body found, inter alia, that Canada
provided, through Special Milk Classes 5(d) an d 5(e), "export subsidies" within the meaning of
Article 9.1(c) of the Agreement on Agriculture. The original panel and the Appellate Body also found
that Canada provided these export subsidies in excess of the quantity commitment levels specified in its
Schedule to the General Agreement on Tariffs and Trade 1994 (the "Schedule") and that, therefore,

1WT/DS103/RW2, WT/DS113/RW2, 26 July 2002. In this Report, we refer to the panel that considered
the second recourse to Article 21.5 of the DSU by New Zealand and the United States—and whose findings are
the subject of this appeal—as the "Panel".
2The recommendations and rulings of the DSB resulted from the adoption, by the DSB, of the panel
report in Canada – Dairy. In this Report, we refer to the panel that considered the original complaint brought by
New Zealand and the United States as the "original panel".

Canada had acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on
Agriculture. On 27 October 1999, the DSB adopted the original panel and Appellate Body reports.
3. On 23 December 1999, pursuant to Article 21.3(b) of the Understanding on Rules and
Procedures Governing the Settlement of Disputes (the "DSU"), Canada, New Zealand, and the
United States agreed that the reasonable period of time for Canada to implement the recommendations
and rulings of the DSB would expire on 31 December 2000.
 3 On 11 December 2000, the parties
agreed to extend this period of time until 31 January 2001. 4
4. Canada subsequently adopted certain measures with a view to implementing the
recommendations and rulings of the DSB. These measures are described in Section II of this
Report. Taking the view that certain of these measures were not consistent with Canada's obligations
under the Agreement on Agriculture and the SCM Agreement, New Zealand and the United States
requested, on 16 February 2001, that the matter be referred to a panel pursuant to Article 21.5 of the
DSU.
 5
5. On the same day, New Zealand and the United States also requested authorization from the
DSB to suspend concessions and other obligations, as provided for in Article 22.2 of the DSU. 6
Canada objected to the level of suspension proposed and the matter was referred to arbitration,
pursuant to Article 22.6 of the DSU.
 7 However, the parties agreed to request the arbitrator to suspend
its work pending the outcome of the Article 21.5 proceedings. 8
6. The panel in Canada – Dairy (Article 21.5 – New Zealand and US) 9 found that Canada
provided, through its "commercial export milk" (" CEM") mechanism, "export subsidies" within the
meaning of Article 9.1(c) of the Agreement on Agriculture. The panel also found that Canada provided
these export subsidies in excess of the quantity commitment levels specified in its Schedule and that,
therefore, Canada had acted inconsistently with its obligations under Articles 3.3 and 8 of the
Agreement on Agriculture. The Appellate Body reversed the panel's findings on the grounds that the
panel had erred in its interpretation of Article 9.1( c). The Appellate Body held that the appropriate
standard, in those proceedings, for determining whether "payments" are made under Article 9.1(c), is

3WT/DS103/10, WT/DS113/10, 7 January 2000.
4WT/DS103/13, WT/DS113/13, 13 December 2000.
5WT/DS103/16, 19 February 2001; WT/DS113/16, 19 February 2001.
6WT/DS103/17, 19 February 2001; WT/DS113/17, 19 February 2001.
7WT/DS103/18, 28 February 2001; WT/DS113/18, 28 February 2001.
9In this Report, we refer to this panel as the "first Article 21.5 panel".

not, as held by the first Article 21.5 panel, the domestic price, but rather the producer's costs of
production. However, in the light of the factual findings made by the first Article 21.5 panel, the
Appellate Body was unable to determine whether the implementation measures involved such
"payments" and, hence, export subsidies within the meaning of Article 9.1(c). Consequently, the
Appellate Body was also unable to determine whether these measures were consistent with
Articles 3.3 and 8 of the Agreement on Agriculture.
 10
7. On 6 December 2001, before adoption of the panel and Appellate Body reports in the first
Article 21.5 proceedings 11, New Zealand and the United States requested the establishment of a
second Article 21.5 panel. They maintained that the measures taken by Canada to comply with the
recommendations and rulings of the DSB of 27 Octobe r 1999, that is, the same measures at issue in
the first Article 21.5 proceedings, were inconsistent with Canada's obligations under the Agreement
on Agriculture. 12
8. On 18 December 2001, Canada, New Zealand, and the United States agreed that the
arbitration previously requested by Canada under Article 22.6 of the DSU would remain suspended
pending the outcome of the second Article 21.5 proceedings.
 13 The parties also agreed that New
Zealand and the United States would request that the work of the Panel be suspended pursuant to
Article 12.12 of the DSU until 18 February 2002.
 14
9. In the Panel Report, circulated to Members of the World Trade Organization (the "WTO") on
26 July 2002, the Panel concluded that:
… Canada, through the CEM scheme and the continued operation of
Special Milk Class 5(d), has acted inconsistently with its obligations
under Articles 3.3 and 8 of the Agreement on Agriculture , by
providing export subsidies within the meaning of Article 9.1(c) of the
 Agreement on Agriculture in excess of its quantity commitment
levels specified in its Schedule for exports of cheese and "other dairy
products". In light of our alternative finding … that Canada has acted
inconsistently with its obligations under Article 10.1 of the
Agreement on Agriculture , we conclude that Canada has acted
inconsistently with its obligations under Article 8 of the Agreement
on Agriculture.
 15

10Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), paras. 126-127.
11The DSB adopted the panel report and the Appellate Body Report in Canada – Dairy (Article 21.5 –
New Zealand and US) on 18 December 2001.
12WT/DS103/23, 6 December 2001; WT/DS113/23, 6 December 2001.
13WT/DS103/24, 2 January 2002; WT/DS113/24, 2 January 2002.
14Ibid. This request, however, did not extend to matters relating to panel composition.
15Panel Report, para. 6.1.

The Panel recommended that the DSB request Canada "to bring its dairy products marketing regime
into conformity with its obligations in respect of export subsidies under the Agreement on
Agriculture." 16
10. On 23 September 2002, Canada notified the DSB of its intention to appeal certain issues of
law covered in the Panel Report and certain legal interpretations developed by the Panel, pursuant to
Article 16.4 of the DSU, and filed a Notice of Appeal pursuant to Rule 20 of the Working Procedures
for Appellate Review (the "Working Procedures"). 17 On 3 October 2002, Canada filed its appellant's
submission. 18 On 18 October 2002, New Zealand and the United States each filed an appellee's
submission. 19 On the same day, Argentina and the European Communities each filed a third
participant's submission. 20 On the same day, Australia notified the Appellate Body Secretariat that,
although it would not file a written submission, it intended to participate at the oral hearing. 21
11. The oral hearing in the appeal was held on 31 October 2002. The participants and Argentina,
Australia, and the European Communities presented oral arguments and responded to questions put to
them by the Members of the Division hearing the appeal.
II. Background
12. The original panel found, inter alia, and the Appellate Body upheld, that Canada provided,
through Special Milk Classes 5(d) and 5(e), "export subsidies" within the meaning of Article 9.1(c) of
the Agreement on Agriculture. It was also found that these subsidies were being provided for quantities
of exports that exceeded the quantity commitment le vel specified in Canada's Schedule. The original
panel concluded, and the Appellate Body upheld, that Canada, therefore, had acted inconsistently with
its obligations under Articles 3.3 and 8 of the Agreement on Agriculture.
 22

16Panel Report, para. 6.3.
17Canada appeals the Panel's findings under Articles 3.3, 8, 9.1(c), 10.1, and 10.3 of the Agreement on
Agriculture.
18Pursuant to Rule 21 of the Working Procedures.
19Pursuant to Rules 22 and 23(3) of the Working Procedures.
20Pursuant to Rule 24(1) of the Working Procedures.
21Pursuant to Rule 24(2) of the Working Procedures.
22Panel Report, Canada – Dairy, para. 8.1(a); Appellate Body Report, Canada – Dairy, para. 144(b).

13. By way of implementation, Canada abolished Special Milk Class 5(e) and restricted export
subsidies under Special Milk Class 5(d) to its commitment levels. 23 At the same time, Canada
established a new class of milk, Class 4(m), under which over-quota milk can be sold as domestic
animal feed. Canada otherwise left unchanged its domestic milk supply management system, under
which domestic milk supply is controlled through the allocation of quota to individual milk producers
by government agencies.
 24 Generally, a producer can sell milk domestically only within the limits of
its quota. The only exception is that a producer can sell over-quota milk in the new Class 4(m) as
domestic animal feed, but for a much lower price.
 25 Moreover, the price of domestic milk is fixed by
government agencies. Government agencies also market domestic milk, collect the sales proceeds
and distribute these proceeds among producers. 26
14. Canada also introduced a new category of milk for export processing, known as "commercial
export milk" ("CEM"). Sales of CEM are made by Canadian producers to Canadian processors, for
processing of that milk into various dairy products for export. These sales are made pursuant to "pre-
commitment" contracts, that is, contracts concluded in advance of milk production.
 27 C a n a d i a n
producers may sell any quantity of CEM to processors on terms and conditions freely negotiated
between the producer and the processor. Sales of CEM do not require a quota or any other form of
permit from the Canadian government or its agencies. Revenues derived from sales of CEM are
collected directly by producers, without government involvement. However, if a dairy product
derived from CEM is sold on the domestic market, the processor is liable to financial penalties for
diverting the dairy product into the domestic market.
 The factual aspects of the new scheme are set
out in greater detail in the Panel Report. 28

23Canada's quantity commitment levels, as contained in Part IV, Section II, of its Schedule, are: 3,500
tonnes for butter; 44,953 tonnes for skim milk powder; 9,076 tonnes for cheese; and 30,282 tonnes for other
milk products.
24In response to questioning at the oral hearing, Canada stated that, when the milk supply management
system was created, quota was allocated among existing farmers. Canada also indicated that quota is a
transferable right and that an active market for quota has developed. The price of quota on this market is
currently in the range of C$15,000-C$30,000/kg of butterfat per day.
25The administered price for Class 4(m) milk is C$10 per hectolitre ("hl"), as opposed to C$49.48/hl
and C$56.06/hl, which is the price range for domestic industrial milk. Canada does not dispute these figures.
26For a more detailed description of the pre-existing milk supply management system see Appellate
Body Report, Canada – Dairy, paras. 6-16; and Panel Report, Canada – Dairy, paras. 2.1-2.66.
27At the oral hearing, Canada informed the Appe llate Body that, generally, producers pre-commit to
sell CEM at least 30 days in advance of the sale.
28Panel Report, paras. 2.2-2.4. See also Panel Report, Canada – Dairy (Article 21.5 – New Zealand
and US), paras. 3.1-3.9. The average CEM price is approximately C$29/hl. (Panel Report, para. 5.60)

III. Written Arguments of the Participants and the Third Participants
A. Claims of Error by Canada – Appellant
1. Article 10.3 of the Agreement on Agriculture—Rules of Evidence
15. Canada argues that the Panel's interpretation of Article 10.3 is "plainly erroneous", as this
provision sets out a "reverse" burden of proof that requires the responding Member to establish a
rebuttable presumption that its measures are not inconsistent with its obligations. It then falls upon
the complaining Members to present evidence and argument to rebut this presumption.
16. Canada contends that the Panel erroneously imposed a minimal burden on the complaining
Members in examining whether they had made out a prima facie case. Canada also submits that it
had presented sufficient evidence to raise a rebuttable presumption showing that there is no export
subsidy and that the United States and New Zealand did not succeed in rebutting this presumption.
Had it properly applied Article 10.3, the Panel would have ruled in favour of Canada.
2. Article 9.1(c) of the Agreement on Agriculture —"Payments Financed by
Virtue of Governmental Action"
17. Canada claims that the Panel erred in finding that Canada's measures provide export subsidies
within the meaning of Article 9.1(c) of the Agreement on Agriculture and disagrees with the Panel's
findings both with respect to "payments" and to "financed by virtue of governmental action".
(a) "Payments"
18. With respect to "payments", Canada argues, first, that the Appellate Body intended the cost of
production standard to be based on the costs of individual dairy farmers and not on a single, industry-
wide average cost of production figure. Canada poi nts to statements of the Appellate Body such as
"each producer decid[ing] for itself ", "value of the milk to the producer", and "cost incurred by the
producer" as demonstrating that the Appellate Body focused on the costs of production of the
individual milk producer. An industry-wide average, in Canada's view, does not have "any relevance"
to the decisions of individual producers participating in CEM transactions.
19. Second, Canada argues that the Panel erred by including imputed returns for family labour,
return to management, and return to equity in a cost of production determination. Imputed returns
constitute government intervention in the marketplace and are included in the Canadian Dairy
Commission (the "CDC") annual cost of production survey to ensure that dairy farmers obtain "a fair

return for their labour and investment". 29 Further, returns to family labour, management, and owner's
equity are derived from the profits of the dairy enterprise. Canada asserts that profits are distinct from
costs and are, therefore, excluded from the cost of production determination.
20. Third, Canada maintains that marketing, transport, and administrative costs are not production
costs and, therefore, should not be included in the cost of production determination. Canada also
disagrees with the Panel's finding that the costs of acquiring quota should be included in the cost of
production determination. Quota costs should be treated as marketing costs confined to the domestic
market and not as relevant in examining export sales. Moreover, Canada considers that quota is an
intangible asset with an indefinite useful life and therefore disagrees with the Panel's conclusion that
Generally Accepted Accounting Principles ("GAAP") permit amortization of quota costs.
21. Finally, Canada disputes the nature of evidence which the Panel, in Canada's view, required in
order to show that "payments" are not being made. According to Canada, the Panel held that there
would be no "payments" if Canada could establish that the individual producer's costs of production
allow the producer to participate in the CEM market without incurring losses. Canada argues that the
Panel, in so holding, required Canada to match the costs of individual producers participating in CEM
transactions with the returns obtained by those same producers. This would place on Canada a burden
that it "cannot possibly be expected to meet".
 30 Canada alleges that Article 9.1(c) cannot contemplate
the existence of "payments" where a Member demonstrates that a significant proportion of producers
have costs of production allowing them to participate in CEM transactions, while recouping their total
cost of production.
(b) "Financed by Virtue of Governmental Action"
22. Canada submits that the Panel erred by finding a "demonstrable link" between the financing
of "payments" on the sale of CEM and Canadian "governmental action". Canada believes that for a
demonstrable link to exist between these two elements, there must be affirmative governmental action
over the decisions of producers, for instance, where the government provides, raises, furnishes, or
manages funds. Canada alleges that, where, as in the present case, government does no more than
establish a framework merely enabling producers and processors, if they so choose, to freely
negotiate the purchase and sale of milk for export, payments are not "financed by virtue of

29See Section 8 of the Canadian Dairy Commission Act (R.S.C. 1985, c. C-15), Exhibit CDA-3
submitted by Canada to the Panel; Exhibit NZ-8 submitted by New Zealand to the Panel.

governmental action". Canada argues that, as the Appellate Body said, the Canadian government
does not oblige or drive producers to produce and sell CEM. 31
23. In Canada's view, exempting processors of CEM from any requirement to pay the domestic
administered price and the prohibition of diversion of CEM into the domestic market are not
demonstrably linked to the financing of any payments and are in no way inconsistent with Canada's
obligations under the covered agreements. Similarly, Canada contends that the practice of pre-
committing sales of CEM does not "finance" payments , but rather ensures that CEM is not surplus
milk.
24. Next, according to Canada, the Panel's reliance upon the notion of "cross-subsidization"
introduces a "foreign" and "open-ended notion" into Article 9.1(c) without this discipline having been
negotiated and accepted by WTO Members.
 32 The domestic regulated price does not finance
"payments" within the meaning of Article 9.1(c) because it is linked only to the domestic market.
Canada further alleges that it makes no sense that a producer would willingly produce additional milk
and sell it at a loss. Canada also contends that a finding of "cross-subsidization" cannot, in any case,
extend to the approximately 100 CEM producers in Canada that do not sell milk in the domestic
market.
3. Article 10.1 of the Agreement on Agriculture—"Export Subsidies"
25. Canada submits that, if the Panel had correctly interpreted item (d) of the Illustrative List of
Export Subsidies (the "Illustrative List") in Annex I of the SCM Agreement in the light of the context
provided by Article 1.1(a)(1)(iv) of that Agreement, it could only have concluded that CEM is not
provided "indirectly through government-mandated schemes". The Panel also erred in rejecting the
evidence presented by Canada, showing that CEM is available on terms as favourable as those
applicable to milk components under Canada's Import for Re-Export Program ("IREP"). Therefore, in
Canada's view, CEM sales do not constitute export subsidies within the meaning of Article 10.1 of the
Agreement on Agriculture.

31Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 117.

B. Written Arguments of New Zealand – Appellee
1. Article 10.3 of the Agreement on Agriculture—Rules of Evidence
26. New Zealand argues that, if the Panel did not apply the burden of proof rules as set forth in
Article 10.3, this was to Canada's advantage, because Canada was relieved from a burden it would
otherwise have borne. Furthermore, the Panel's analysis "makes clear" that the Panel did require
Canada to establish that no export subsidy existed and that Canada failed to discharge that burden.
New Zealand submits that, in any event, any error made by the Panel in interpreting Article 10.3 had
no impact on the outcome of the case.
2. Article 9.1(c) of the Agreement on Agriculture —"Payments Financed by
Virtue of Governmental Action"
(a) "Payments"
27. New Zealand contends that Canada's objections to the Panel's application of the average total
cost of production standard are founded on a rejection of this standard's inherent logic. Canada's
approach would make the standard "fundamentally unworkable" and would "void it of any content".
 33
28. New Zealand submits, first, that a determination whether producers make sales of CEM at
prices below the average total cost of production can be made only by looking at an average industry-
wide determination of the total cost of production. According to New Zealand, a determination of the
average total cost of production on the basis of individual producer costs of production, as proposed
by Canada, is "simply unworkable"
 34 and implies that the average total cost of production of each and
every Canadian producer would have to be considered in order to determine whether any "payments"
have been made.
29. Second, New Zealand argues that imputed costs of family labour, return to management, and
return to equity must be included in the cost of production determination, because these costs
represent costs incurred by the producer. New Zealand considers that these imputed costs are distinct
from profits, as profits are "something over and above" all fixed and variable costs.
 35 New Zealand
also believes that the Panel was correct to rely on CDC cost of production data, as these are based on
an objective study and are subject to audit.

33New Zealand's appellee's submission, paras. 3.08 and 3.17.
34Ibid., para. 3.35.
35Ibid., para. 3.23.

30. Third, New Zealand submits that Canada's complaint about the Panel's treatment of transport
and marketing costs, as well as of quota costs, is also without merit. All these costs, according to
New Zealand, are costs incurred by the producers that must be recouped in the sales price. Describing
costs as "marketing" costs, rather than "production" costs, does not alter this fact. New Zealand also
argues that the cost of quota cannot be eliminated by assigning it to the domestic market, because the
Appellate Body has said that costs related to both the domestic and the export markets have to be
taken into consideration.
(b) "Financed by Virtue of Governmental Action"
31. New Zealand opines that the essence of Canada's objections to the Panel's conclusions on the
phrase "financed by virtue of governmental action" is that the relevant governmental action does not
"oblige" or "drive" producers to "produce and sell" CEM. However, in New Zealand's view, the
Appellate Body did not find that "payments" can only be "financed by virtue of governmental action"
where producers are "obliged" or "driven" to produce and sell CEM. Rather, the Panel correctly
examined whether there was a demonstrable link between the governmental action and the financing
of "payments".
32. In New Zealand's view, exempting the processor from the requirement to pay the higher
domestic price is clearly linked to the financing of "payments". The sole purpose of the exemption is
to make milk available for export processing. This would not be possible if processors had to
purchase milk at the domestic price.
33. With respect to the Canadian argument that the notion of "cross-subsidization" is "foreign" to
the Agreement on Agriculture and any other covered agreement, New Zealand claims that cross-
subsidization is relevant under the Agreement on Implementation of Article VI of the General
Agreement on Tariffs and Trade 1994 (the " Anti-Dumping Agreement
 "). Also, the possibility of
cross-subsidization under Article 9.1(c) was identified, as a relevant consideration, by the Appellate
Body in the first Article 21.5 proceedings.
3. Article 10.1 of the Agreement on Agriculture—"Export Subsidies"
34. In New Zealand's view, Canada's arguments that the Panel should have derived guidance from
Article 1 of the SCM Agreement in its interpretation of item (d) of the Illustrative List of the
SCM Agreement would artificially narrow the scope of item (d). The Panel, in New Zealand's view,
applied item (d) in accordance with its terms, and it was unnecessary to look elsewhere to restrict or

expand the scope of that provision. New Zealand also agrees with the Panel that IREP imports are
available to export processors on commercially less favourable terms than CEM.
C. Written Arguments of the United States – Appellee
1. Article 10.3 of the Agreement on Agriculture—Rules of Evidence
35. The United States argues that Canada's objection to the Panel's interpretation of Article 10.3
overlooks the fact that the Panel's approach could only serve to benefit Canada, since the Panel
unnecessarily examined initially whether the complainants had made out a prima facie case.
However, the United States is of the view that this additional step did not change the outcome of the
dispute.
2. Article 9.1(c) of the Agreement on Agriculture —"Payments Financed by
Virtue of Governmental Action"
(a) "Payments"
36. The United States opines that the Panel properly concluded that Canadian milk producers are
making "payments" to Canadian milk processors. First, the United States submits that the Panel
correctly found that the Appellate Body, in the first Article 21.5 proceedings, did not intend an
individual cost of production standard and that a cost of production benchmark based on individual
producers was "unworkable". 36
37. Second, the United States agrees with the Panel that all economic costs should be included in
the cost of production benchmark. With respect to imputed costs, the Panel correctly recognized that
investment of family labour, management, and capital in the dairy enterprise involves economic
opportunity costs. The fact that the CDC calculat es these costs annually and includes them in its
survey of costs of production contradicts Canada's argument that a determination of a proper amount
for imputed returns to family labour, management, and owner's equity is inherently speculative as
well as subjective. The United States asserts that the use of this data to establish the domestic
regulated price does not detract from the validity of this data.
38. Third, the United States also agrees with the Panel that marketing, transportation, and
administrative costs are to be included in the cost of production standard, as they represent real costs
that a producer must recoup in order to remain in business over time. Similarly, the cost of obtaining

a production quota represents a real cost that a producer will incur in the production of milk,
regardless of its treatment under accounting principles.
39. Finally, the United States submits that the Panel correctly found that Canada's individual
producer data does not establish that producers are not making "payments" to processors. Canada was
unable to provide evidence correlating individual producer's costs of production with sales by each
producer in the CEM market, and the Panel correctly declined to assume that only those producers
with costs of production below the CEM price participate in the CEM market.
(b) "Financed by Virtue of Governmental Action"
40. The United States argues that Canada's objectio ns to the Panel's findings with respect to the
phrase "financed by virtue of governmental action" are without merit. The United States disagrees
with Canada's apparent contention that the Appellate Body has already ruled on the governmental
action element of Article 9.1(c). The Appellate Body did not find that Article 9.1(c) requires that
producers be "obliged" or "driven" to produce additional milk for export.
41. In the United States' view, the Appellate Body explained, in the first Article 21.5 proceedings,
that relevant governmental action could include the regulation of the supply and price of milk in the
domestic market. The Panel then rightly concluded that a profit-maximizing milk producer will
consider the extent to which the cost-covering, regulated price of domestic milk allows it to make
additional sales in the CEM market while still covering its marginal costs. Canada is incorrect in its
assertion that the Panel found that Canadian governmental action merely makes it possible for
producers to make "payments".
42. The United States agrees that Canada's policies of exempting the processor from paying the
higher domestic price, and of prohibiting diversion of CEM into the domestic market support the
Panel's finding that payments are "financed by virtue of governmental action". Through these
policies, Canadian governmental action ensures that the bulk of non-quota milk will be channelled
into the CEM market.
43. The United States also agrees with the Panel that the requirement to pre-commit CEM sales
creates an additional incentive to dedicate a larger quantity of milk to the CEM market than would
otherwise be the case. As a result, the pre-commitment policy supports the Panel's finding of a
"demonstrable link" between governmental action and the financing of "payments".

44. Finally, the United States believes that Canada mischaracterizes the Panel's analysis of
Canada's regulation of the domestic supply and price of milk. The Panel did not create any new form
of subsidization or new WTO obligation; rather, the Panel "carefully" followed the Appellate Body's
guidance in this regard and used the term "cross-s ubsidization" as a convenient shorthand expression
in its analysis of the governmental action in the form of the regulation of the domestic price and
supply of milk.
 37 The United States asserts that the Panel carefully considered whether the domestic
regulated price allowed producers to engage in less remunerative CEM sales, while at least covering
their marginal costs of production.
3. Article 10.1 of the Agreement on Agriculture—"Export Subsidies"
45. According to the United States, the Panel correctly found that Canada's CEM scheme is
inconsistent with Article 10.1 of the Agreement on Agriculture. Contrary to Canada's allegations, the
Panel did not overlook relevant context in applying item (d) of the Illustrative List of the
SCM Agreement. Furthermore, the United States agrees with the Panel that Canadian milk processors
obtain CEM at more favourable terms than whole milk powder through IREP.
D. Written Arguments of the Third Participants
1. Argentina
46. Argentina agrees broadly with the Panel's r easoning under Article 9.1(c) and considers that,
given the characteristics of the Canadian milk supply system—as discussed by the Panel—,Canadian
producers will channel their surplus production into the CEM market. Argentina also submits that the
use of the phrase "by virtue of
 ", rather than of the word "by", indicates that Article 9.1(c) covers
circumstances where "payments" are not financed directly by government, and where government
does not intervene directly in the provision of "payments", but nevertheless creates "a whole set of
circumstances" that ultimately lead to "payments" on exports.
 38
47. As regards Article 10.1 of the Agreement on Agriculture, Argentina concurs with the Panel
that Canada failed to establish the absence of th e three elements of export subsidies contemplated by
item (d) of the Illustrative List of the SCM Agreement. A governmental measure that falls under
item (d) of the Illustrative List of the SCM Agreement is, at the same time, an "export subsidy"
within the meaning of Article 10.1, even if no charge on the public account is involved.

38Argentina's third participant's submission, para. 26.

2. European Communities
48. The European Communities agrees with Canada that the Panel incorrectly interpreted
Article 10.3 of the Agreement on Agriculture. The correct standard of proof to be applied in this case
is that Canada should make out a prima facie case to establish that its measure does not constitute an
"export subsidy".
49. With respect to the issue of "payments" under Article 9.1(c) of the Agreement on
Agriculture, the European Communities considers that the average total cost of production is not the
appropriate benchmark for assessing whether there are "payments" within the meaning of
Article 9.1(c). The Panel's standard makes it possible to find a subsidy where no "benefit" is provided
and, in any event, the standard is "unworkable".
 39 The Panel also erred in including in the cost of
production standard an amount for profit as well as cost items such as family labour, return on
management, and return on equity. Finally, in examining the evidence of "payments", the Panel
imposed an insurmountable burden of proof on Canada.
50. With respect to the phrase "financed by vi rtue of governmental action", the European
Communities "fully supports" Canada's appeal.
 40 The Panel applied a standard that contradicts the
Appellate Body's guidance in that the Panel found th at it was sufficient to show that governmental
action makes sales possible. None of the four governmental actions identified by the Panel—that is,
prohibition on diversion of CEM into the domestic market; the exemption of export processors from
paying the fixed domestic price; cross-subsidization; and the pre-commitment requirement—is
sufficient to establish that producers are obliged or driven to provide CEM.
51. The European Communities opines that the Panel added to the obligations under
Article 9.1(c) of the Agreement on Agriculture . An interpretation of the term "financed" as also
covering payments-in-kind goes beyond the ordinary meaning of the term. Article 9.1(c) includes
private party payments only to the extent that "payments" are financed from the proceeds of a levy
imposed on the agricultural product concerned. Accordingly, the European Communities submits
that, for a measure to fall under Article 9.1(c), the government must "impose" or "mandate"
payments.
 41

39European Communities' third participant's submission, title of section IV.A.1 (b), p. 12.
40Ibid., para. 67.
41Ibid., title of section IV.B.4 (b), p. 25.

52. The European Communities further contends that the Panel's findings are based on the
assumption that WTO Members intended to prevent cross-subsidization, that is, that WTO Members
intended to target the omission of governments to prevent the "natural economic behaviour" of cross-
subsidization.
 42 However, Article 9.1(c), like all WTO law, is concerned only with governmental
actions, not also with governmental omissions.
53. The European Communities disagrees with the Panel's findings on Article 10.1 of the
Agreement on Agriculture . The notion of an export subsidy under this provision must be read
"co-extensively" 43 with the basic definition of subsidies under the SCM Agreement, unless the
Agreement on Agriculture contains an explicit derogation. In the European Communities' view, the
measure at issue does not meet the basic definitional elements for a "financial contribution", under
Article 1.1(a)(1)(iv) of the SCM Agreement, because it does not "entrust or direct a private body to
carry out" a function otherwise carried out by governments. Nor is the measure a "government-
mandated scheme" within the meaning of item (d) of the Illustrative List of the SCM Agreement.
IV. Issues Raised in this Appeal
54. This appeal raises the following issues:
(a) whether the Panel erred, in paragraph 5.18 of the Panel Report, in its finding under
Article 10.3 of the Agreement on Agriculture , with respect to the allocation of the
burden of proof under that provision;
(b) whether the Panel erred, in paragraphs 5.89 and 5.135 of the Panel Report, in its
finding under Article 9.1(c) of the Agreement on Agriculture, in particular, in finding
that "commercial export milk" ("CEM") involves "payments" and that these
"payments" are "financed by virtue of governmental action"; and
(c) whether the Panel erred, in paragraph 5.165 of the Panel Report, in reaching its
alternative finding under Article 10.1 of the Agreement on Agriculture , that CEM
involves export subsidies applied in a manner that is inconsistent with that provision.

42European Communities' third participant's submission, para. 115.
43Ibid., para. 125.

V. Article 10.3 of the Agreement on Agriculture— Rules of Evidence
55. At the outset of its findings, the Panel considered the significance of Article 10.3 of the
Agreement on Agriculture for these proceedings. The Panel noted that the parties were in agreement
that, under Article 10.3, Canada—the responding Member—bears the burden of proof. 44
Accordingly, the Panel opined that, if the complaining Members demonstrated "that Canada has
exceeded its export subsidy reduction commitment levels on certain dairy products", it would be for
Canada to establish that it is not providing export subsidies in relation to the exports exceeding its
commitment levels.
 45 In that respect, the Panel stated that:
… an operational interpretation of Article 10.3 requires that the
Complainants make a prima facie showing that the elements of the
claimed export subsidies are present.
… [P]rovided that the Complainants make out a prima facie case that
certain elements of the Canadian regulation of its dairy industry
constitute export subsidies under either Article 9.1(c) or Article 10.1,
it will then be for Canada, pursuant to Article 10.3 of the Agreement
on Agriculture … to establish that [these products] do not benefit from
these particular types of export subsidies. 46 (underlining added)
56. Thus, the Panel envisaged a three-step process under Article 10.3:
(i) The complaining Member(s) must demonstrate that the responding Member has
exported an agricultural product in quantities that exceed the quantity commitment
level specified in its Schedule to the General Agreement on Tariffs and Trade 1994
(the "Schedule");
(ii) the complaining Member(s) must next "make out" a prima facie case that "the
elements of the claimed export subsidies" are present; and
(iii) the responding Member(s) must establish that no export subsidy has been granted
for exports of the product in excess of the quantity commitment level.

44Panel Report, para. 5.13. See also Panel Report, paras. 3.4-3.5.
45Ibid., para. 5.15.
46Ibid., paras. 5.18-5.19.

57. Canada considers that the Panel erred by requiring the complaining Members to make out a
prima facie case of their claims. In consequence, Canada argues that the Panel failed properly to
apply the burden of proof. Canada asserts that Article 10.3:
… sets out a reverse burden of proof, which … requires the
respondent to establish a rebuttable presumption that its measures are
not inconsistent. It is then up to the complainant to present evidence
and argument that rebuts this presumption.
 47
58. In its appeal, Canada submits that the original panel in Canada – Dairy 48 correctly
interpreted Article 10.3.
59. In the original panel proceedings, the panel made the following remarks on Article 10.3:
This provision shifts the burden of proof from the complainant to the
defendant. A defending party (i.e., the exporting country) alleging
that exports in excess of its reduction commitment level are not
subsidized must demonstrate that no export subsidy in respect of this
excess has been granted. All parties in dispute agree that the wording
of Article 10.3 has this effect of reversing the usual burden of proof.
 49
(emphasis added; footnote omitted)
60. The original panel did not require the complaining Member to make out a prima facie case;
that is, the second step above was not included in the reasoning. Instead, the original panel read
Article 10.3 as allocating the burden of proof to the responding Member to demonstrate that no
subsidies were provided for exports exceeding the commitment levels (that is, the third step above).
 50
61. In the first Article 21.5 proceedings, the panel expressed a very similar view, opining that
"when reduction commitments have been exceeded, Article 10.3 has the effect of reversing the usual
burden of proof
 ". 51 That panel did not require the complaining Members to make out a prima facie
case of the elements of the claimed export subsidy.

48In this Report, we refer to the panel that considered the original complaint brought by New Zealand
and the United States as the "original panel".
49Panel Report, Canada – Dairy, para. 7.33.
50The original panel also established that Canada had exported dairy products in quantities exceeding
the quantity commitment level (that is, the first step above). (Ibid., para. 7.34)
51Panel Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 6.3.

62. The meaning of Article 10.3 of the Agreement on Agriculture was also addressed in the
original proceedings in US – FSC. In that dispute, the panel considered it "evident" that Article 10.3
"shifts" or, as it also said, "reverses", the usual rule that the burden of proof is on the complaining
Member to establish its claims.
 52 That panel also made no mention of any requirement for the
complaining Member to make out a prima facie case of the elements of the claimed export subsidy.
63. Although Article 10.3 of the Agreement on Agriculture has been examined by several
panels, this is the first time that we examine the interpretation of this provision.
64. Before addressing Article 10.3, it is useful to recall our view of the burden of proof as a
general matter. This issue was first examined in US – Wool Shirts and Blouses, where we stated that:
… various international tribunals, including the International Court of
Justice, have generally and consistently accepted and applied the rule
that the party who asserts a fact, whether the claimant or the respondent,
is responsible for providing proof thereof. Also, it is a generally-
accepted canon of evidence in civil law, common law and, in fact, most
jurisdictions, that the burden of proof rests upon the party, whether
complaining or defending, who asserts the affirmative of a particular
claim or defence. If that party adduces evidence sufficient to raise a
presumption that what is claimed is true, the burden then shifts to the
other party, who will fail unless it adduces sufficient evidence to rebut
the presumption.
 53 (footnotes omitted)
65. In EC – Hormones, we said:
The initial burden lies on the complaining party, which must establish
a prima facie case of inconsistency with a particular provision of the
SPS Agreement on the part of the defending party, or more precisely,
of its SPS measure or measures complained about. When that prima
facie case is made, the burden of proof moves to the defending party,
which must in turn counter or refute the claimed inconsistency. 54
66. Thus, we have consistently held that, as a general matter, the burden of proof rests upon the
complaining Member. That Member must make out a prima facie case by presenting sufficient
evidence to raise a presumption in favour of its claim. If the complaining Member succeeds, the
responding Member may then seek to rebut this presumption. Therefore, under the usual allocation of
the burden of proof, a responding Member's measure will be treated as WTO- consistent, until

52Panel Report, US – FSC, paras. 7.136 and 7.161.
53Appellate Body Report, US – Wool Shirts and Blouses, at 335.

sufficient evidence is presented to prove the contrary. We will not readily find that the usual rules on
burden of proof do not apply, as they reflect a "canon of evidence" accepted and applied in
international proceedings.
67. Article 10.3 of the Agreement on Agriculture reads:
Prevention of Circumvention of Export Subsidy Commitments
…
3. Any Member which claims that any quantity exported in
excess of a reduction commitment level is not subsidized must
establish that no export subsidy , whether listed in Article 9 or not,
has been granted in respect of the quantity of exports in question.
(emphasis added)
68. This provision requires that a specific Member, in defined circumstances, "establish that no
export subsidy … has been granted". We begin by identifying the specific Member and
circumstances to which Article 10.3 applies. The provision refers to a Member making a "claim" that
certain exports are "not [being] subsidized". Although the word "claim" usually refers to an assertion
by a complaining Member that a measure is WTO- inconsistent, in this provision the word "claim"
refers to an assertion by a responding Member that a measure is WTO- consistent. The "claim" to
which Article 10.3 refers is, therefore, a defensive argument made by the responding Member.
69. Article 10.3 does not impose any substantive obligations regulating the grant of export
subsidies under the Agreement on Agriculture. Rather, Article 10.3 provides a special rule for proof
of export subsidies that applies in certain disputes under Articles 3, 8, 9, and 10 of the Agreement on
Agriculture.
70. In identifying the nature of the special rule, it is useful to analyze the character of claims
brought under these provisions. Pursuant to Article 3 of the Agreement on Agriculture, a Member is
entitled to grant export subsidies within the limits of the reduction commitment specified in its
Schedule.
 55 Where a Member claims that another Member has acted inconsistently with Article 3.3
by granting export subsidies in excess of a quantity commitment level, there are two separate parts to
the claim. First, the responding Member must have exported an agricultural product in quantities
exceeding its quantity commitment level. If the quantities exported do not reach the quantity
commitment level, there can be no violation of that commitment, under Article 3.3. However, merely
exporting a product in quantities that exceed the quantity commitment level is not inconsistent with

55Under Articles 3.1 and 3.3 of the Agreement on Agriculture , "commitments limiting subsidization"
of exports are specified in the Schedule in terms of "budgetary outlay and quantity commitment levels".

the commitment. The commitment is an undertaking to limit the quantity of exports that may be
subsidized and not a commitment to restrict the volume or quantity of exports as such. The second
part of the claim is, therefore, that the responding Member must have granted export subsidies with
respect to quantities exceeding the quantity comm itment level. There is, in other words, a
quantitative aspect and an export subsidization aspect to the claim.
71. Under the usual rules on burden of proof, the complaining Member would bear the burden of
proving both parts of the claim. However, Article 10.3 of the Agreement on Agriculture partially
alters the usual rules. The provision cleaves the complaining Member's claim in two, allocating to
different parties the burden of proof with respect to the two parts of the claim we have described.
72. Consistent with the usual rules on burden of proof, it is for the complaining Member to prove
the first part of the claim, namely that the responding Member has exported an agricultural product in
quantities that exceed the responding Member's quantity commitment level.
73. If the complaining Member succeeds in proving the quantitative part of the claim, and the
responding Member contests the export subsidization aspect of the claim, then, under Article 10.3, the
responding Member " must establish that no export subsidy … has been granted" in respect of the
excess quantity exported. (emphasis added) The language of Article 10.3 is clearly intended to alter
the generally-accepted rules on burden of proof. The verb "establish" is synonymous with the verbs
"demonstrate" and "prove".
 56 Moreover, the auxiliary verb "must" conveys that the responding
Member has an obligation—or legal burden—to "establish" or "prove" that "no export subsidy … has
been granted".
74. The plain meaning of the text is borne out by the immediate context of Article 10.3 of the
Agreement on Agriculture . Article 10 is entitled " Prevention of Circumvention of Export Subsidy
Commitments". As a subparagraph of this provision, Article 10.3 pursues this aim. The significance
of Article 10.3 is that, where a Member exports an agricultural product in quantities that exceed its
quantity commitment level, that Member will be treated as if it has granted WTO- inconsistent export
subsidies, for the excess quantities, unless the Member presents adequate evidence to "establish" the
contrary. This reversal of the usual rules obliges the responding Member to bear the consequences of
any doubts concerning the evidence of export subsidization. Article 10.3 thus acts as an incentive to
Members to ensure that they are in a position to demonstrate compliance with their quantity
commitments under Article 3.3.

56The Shorter Oxford English Dictionary , C.T. Onions (ed.) (Guild Publishing, 1983), Vol. I, p. 682;
Roget's Thesaurus of English words and phrases (Longman Group Limited, 1982), p. 809.

75. With respect to the export subsidization part of the claim, the complaining Member, therefore,
is relieved of its burden, under the usual rules, to establish a prima facie case of export subsidization
of the excess quantity, provided that this Member has established the quantitative part of the claim.
We, therefore, do not agree with the Panel that the complaining Member must make out a prima
facie case in support of this part of its claim. In practice, the complaining Member may wish to
present evidence to rebut any evidence presen ted by the responding Member. However, the
complaining Member is not required to lead in the presentation of evidence to panels, and it might
well succeed in its claim even if it presents no ev idence—should the responding Member fail to meet
its legal burden to establish that no export subsidy has been granted with respect to the excess
quantity.
76. We, therefore, find that the Panel erred, in paragraph 5.18 of the Panel Report, in its
interpretation of Article 10.3 of the Agreement on Agriculture , by imposing upon the complaining
Members the duty to make out a prima facie case in support of all aspects of their claims under
Articles 3.3, 8, 9.1(c), and 10.1.
 57 When the Panel had determined that the complainants had
established that Canada had exported dairy products in quantities exceeding its quantity commitment
levels, it should have proceeded directly to require Canada to establish that the exports of dairy
products did not benefit from export subsidies. Instead, the Panel's next step was to require the
complaining Members to "make a prima facie showing that the elements of the claimed export
subsidies are present."
 58 However, as the Panel found that the complaining Members had made out
such a prima facie case, the Panel went on correctly to hold that it is for Canada "to establish that
Canadian exports of cheese and 'other milk products' do not benefit from these particular types of
export subsidies."
 59
77. Thus, although the Panel's interpretation was in error, this error does not vitiate any of the
Panel's findings under Articles 3.3, 8, 9.1(c), and 10.1 of the Agreement on Agriculture. The Panel
found that the complaining Members had made out a prima facie case that CEM involved export
subsidies. Although the Panel should not have engaged in this inquiry, the inquiry led the Panel to
find, correctly, that Canada was obliged to prove that it had not granted export subsidies for the dairy
products exported in excess of the quantity commitment level. The Panel, therefore, arrived at the
legal situation envisaged by Article 10.3 and, thereafter, properly applied the rules on burden of proof
in that provision with respect to proof of the export subsidization aspect of the claim. The Panel

57The Panel reiterated this error in paragraph 5.19 of the Panel Report.
58Panel Report, para. 5.18.
59Ibid., para. 5.19.

concluded that Canada "failed to establish" that CEM did not involve export subsidies. 60 W e w i l l
examine, below, the appeals that Canada makes against this finding under Articles 9.1(c) and 10.1 of
the Agreement on Agriculture. However, we see no reason to disturb these findings on the grounds
that the Panel misinterpreted Article 10.3.
VI. Article 9.1(c) of the Agreement on Agriculture —"Payments Financed by Virtue of
Governmental Action"
78. The second issue appealed by Canada is whether the Panel erred in its interpretation and
application of Article 9.1(c) of the Agreement on Agriculture . This issue raises two separate
questions: (a) whether the Panel erred in finding that CEM involves " payments" under Article 9.1(c);
and (b) having found that CEM involves "payments", whether the Panel erred in finding that these
"payments" are "financed by virtue of governmental action". We will examine these questions in turn.
79. Before turning to the question of "payments", we note that Canada does not appeal, and we
will not address, the Panel's finding that the alleged CEM payments are made " on the export
 " of
agricultural products, as required by Article 9.1(c) of the Agreement on Agriculture. 61
A. "Payments"
80. The Panel began its reasoning by recalling that "payments" under Article 9.1(c) of the
Agreement on Agriculture include "payments-in-kind" made through the supply of goods or
services. 62 The Panel noted that we held, in the first Article 21.5 proceedings, that the existence of
payments-in-kind, for purposes of CEM, should be determined by comparing CEM prices with "some
objective standard … reflect[ing] the proper value" of milk to the producer.
 63 The Panel also
observed that we held that "the average total cost of production represents the appropriate standard"
in these proceedings. 64

60Panel Report, paras. 5.136 and 5.164.
61See ibid., para. 5.23.
62Ibid., para. 5.26, referring to Appellate Body Report, Canada – Dairy, para. 112; and to Appellate
Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), paras. 71 and 76.
63Ibid., para. 5.27, referring to Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand
and US), paras. 74-75, 96, and 104.
64Ibid., para. 5.28, referring to Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand
and US), para. 87. (emphasis added) See also Appellate Body Report, Canada – Dairy (Article 21.5 – New
Zealand and US), para. 96.

81. Before the Panel, the parties disagreed as to how the average total cost of production standard
(the "COP standard") should be determined. The Panel "doubted" that Canada was correct to argue
that the standard should be each individual producer's costs of production, rather than a single
industry-wide average figure, as proposed by the complaining Members.
 65 The Panel also found that
Canada did not demonstrate why imputed costs for family labour and management, and for owner's
equity, as well as quota, transport, marketing, and administrative costs, should not be included in
calculating the COP standard, as suggested by the complaining Members.
 66
82. Despite these doubts regarding Canada's position, the Panel made two distinct findings on the
existence of "payments"; one based on Canada's interpretation of the COP standard and the other
based on the complaining Members' interpretation. The Panel ruled that, even assuming Canada's
interpretation of the standard were correct , the evidence submitted by Canada did not support
Canada's position that payments were not made. 67 The Panel also considered that the complaining
Members' evidence was sufficient to establish a prima facie case that payments were made, on the
basis of their interpretation of the COP standard. 68
83. As the Panel came to an identical conclusion under both interpretations of the COP standard,
it concluded that it was "unnecessary [for it] to decide in this case which of these two interpretations
is the correct one." 69 Therefore, the Panel did not express any definitive views on the proper
application of the COP standard.
84. In its appeal, Canada makes four primary arguments on the question of "payments". Canada
contends: first, that the Panel erred in considering that the COP standard should be applied on an
industry-wide basis; second, that the Panel erre d in finding that the COP standard includes "non-
monetary costs", such as the costs of family labour and management, and of owner's equity, that do
not represent actual cash costs incurred by the producer; third, that the Panel erred in finding that the
COP standard extends to costs associated with selli ng milk, such as quota, transport, marketing, and
administrative costs, whereas Canada submits that it covers only the on-farm costs of producing milk;
and fourth, that the Panel erred in its assessment of the evidence by placing a burden on Canada that it

65Panel Report, paras. 5.50-5.51.
66Ibid., para. 5.85.
67Ibid., paras. 5.65 and 5.87.
68Ibid., paras. 5.34 and 5.86.
69Ibid., para. 5.90. (original italics; underlining added) We note, however, that the Panel also stated, in
paragraph 5.126 of the Panel Report, that "imputed costs of family labour, return to management, return to
equity, and production quota, as well as transport, marketing and administrative costs … are properly to be
included in a calculation of the average total cost of production."

"cannot possibly be expected to meet". 70 Before examining these four arguments, we provide general
observations relating to Article 9.1(c).
1. General Remarks on Article 9.1(c) of the Agreement on Agriculture
85. The word "payment", in Article 9.1(c) of the Agreement on Agriculture, denotes a "transfer
of economic resources". 71 Although a monetary payment certainly involves such a transfer, the same
is equally true where goods or services are transferred for less than full value. Recognizing this, we
upheld the original panel's finding that the ordinary meaning of the word "payment", in Article 9.1(c)
of the Agreement on Agriculture, "encompasses 'payments' made in forms other than money". 72
86. In these second Article 21.5 proceedings, New Zealand and the United States assert that non-
monetary "payments" are effected through the supply of goods—CEM. The issue is, therefore,
whether supplies of CEM, by Canadian producers, involve a transfer of economic resources to
processors.
87. In examining this question in the first Article 21.5 proceedings, we took into account that
Article 9.1(c) of the Agreement on Agriculture describes an unusual form of subsidy in that
"payments" can be made by private parties, and need not be made by government.
 73 Moreover,
"payments" need not be funded from government resources, provided they are "financed by virtue of
governmental action". 74 Article 9.1(c), therefore, contemplates that "payments" may be made and
funded by private parties, without the type of gove rnmental involvement ordinarily associated with a
subsidy. Furthermore, the notion of payments encompasses a diverse range of practices involving
monetary transfers, or transfers-in-kind. We, th erefore, determined that, in identifying whether
"payments" are made, it is necessary to consider the particular features of the alleged "payments", by
whom they are made, and in what circumstances. Thus, we found that the standard for determining
the existence of "payments" under Article 9.1(c) must be identified after careful scrutiny of the factual
and regulatory setting of the measure.
 75

72Ibid., para. 112.
73Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), paras. 113 and 115.
74Ibid., para. 114.
75Ibid., para. 76.

88. In the case of CEM, we took into account the fact that the alleged "payments" are made by
private parties through the supply of milk. Moreover, subject to the requirement to pre-commit sales
of CEM, the private parties are entirely free to produce milk for sale as CEM, and it is for them to
agree the price, volume, and timing of the sale with the buyers.
 76 In these particular circumstances,
we considered that the determination of whether "payments" are made depends on a comparison
between the price of CEM and an "objective standard or benchmark which reflects the proper value of
the [milk] to [its] provider".
 77 We found that, in the circumstances of this dispute, the standard for
determining the proper value of CEM is the average total cost of production of the milk (the COP
standard), as this standard represents the economic resources the producer invests in the milk. If
CEM is sold at less than its proper value, "payments" are made, because there is a transfer of the
portion of economic resources not reflected in the selling price.
89. We also provided certain guidance on the determination of the COP standard:
The average total cost of production would be determined by dividing
the fixed and variable costs of producing all milk, whether destined
for domestic or export markets, by the total number of units of milk
produced for both these markets.
 78 (original italics)
90. With these general observations in mind, we turn to Canada's four primary arguments on
"payments".
2. Individual Producer's Costs of Production or Industry-wide Average
91. Canada argues that the Panel erred in considering that the COP standard is a single, industry-
wide average cost of production figure, rather than each individual producer's costs of production. 79
92. Although the Panel expressed "doubts" that the COP standard should be each individual
producer's costs, rather than an industry-wide figure, we note that it did not reach a definitive view on

76In response to questioning at the oral hearing, Ca nada affirmed us that pre-commitment of CEM sales
must be made at least 30 days in advance of the sale date.
77Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 74.
78Ibid., para. 96.
79We note that, although Canada argues that the COP standard should be each individual producer's
costs of production, Canada presented evidence based on ten industry-wide groupings, giving an average cost of
production figure for each of these groups. For each group or "decile", Canada gave the lowest and highest
individual cost of production figure. The Panel also makes this point: "While speaking of the costs to
individual producers, not industry-wide average costs, Canada has only provided the Panel with average costs,
albeit averages within ten groupings of producers." (Panel Report, para. 5.64)

this question. 80 Instead, as we said, the Panel examined the evidence from the perspective of the
alternative positions, and found against Canada under each of them. 81
93. Canada asserts that we found, in the first Article 21.5 proceedings, that the COP standard is
based on individual producer's costs of production. However, this question was not specifically
examined, nor resolved, in the first Article 21.5 proceedings.
94. For purposes of resolving this question, it is relevant to consider the nature of the
obligations imposed under the Agreement on Agriculture. That Agreement, which is annexed to the
Marrakesh Agreement Establishing the World Trade Organization , is an international agreement to
which Canada is a party, as a sovereign State. Pursuant to this Agreement, Canada has undertaken a
number of different obligations. Among these are the obligations in Articles 3.3 and 8 of the
Agreement on Agriculture not to provide export subsidies otherwise than in conformity with this
Agreement and with the commitments as specified in that Member's Schedule. Accordingly, under
Article 3.3, Canada has undertaken not to provide the export subsidies listed in Article 9.1 "in excess
of … [its] quantity commitment levels".
95. However, under Article 9.1(c) of the Agreement on Agriculture, it is not solely the conduct
of WTO Members that is relevant. We have noted that Article 9.1(c) describes an unusual form of
export subsidy in that "payments" can be made and funded by private parties, and not just by
government.
 82 The conduct of private parties, therefore, may play an important role in applying
Article 9.1(c). Yet, irrespective of the role of private parties under Article 9.1(c), the obligations
imposed in relation to Article 9.1(c) remain obligations imposed on Canada. It is Canada, and not
private parties, which is responsible for ensuring that it respects its export subsidy commitments under
the covered agreements. Thus, under the Agreement on Agriculture, any "export subsidies" provided
through private party action in Canada are deemed to be provided by Canada, and count towards
Canada's export subsidy commitment levels.
96. We believe that the standard for determining the existence of "payments", under
Article 9.1(c), should reflect the fact that the obligation at issue is an international obligation imposed
on Canada. The question is not whether one or more individual milk producers, efficient or not, are
selling CEM at a price above or below their individual costs of production. The issue is whether
Canada, on a national basis, has respected its WTO obligations and, in particular, its commitment

80Panel Report, paras. 5.50 and 5.90.
81Ibid., paras. 5.86-5.87.
82Supra, para. 87.

levels. It, therefore, seems to us that the benchmark should be a single, industry-wide cost of
production figure, rather than an indefinite number of cost of production figures for each individual
producer. The industry-wide figure enables cost of production data for producers, as a whole, to be
aggregated into a single, national standard that can be used to assess Canada's compliance with its
international obligations.
97. By contrast, if the benchmark were to operate at the level of each individual producer, there
would be a proliferation of standards, requiring individual-level inquiry and application of
Article 9.1(c), as if the obligations under the Agreement on Agriculture involved rights and
obligations of individual producers, rather than WTO Members.
98. We, therefore, find that the COP standard for determining whether the sale of CEM involves
"payments", under Article 9.1(c) of the Agreement on Agriculture, is an industry-wide average figure
that aggregates the costs of production of all producers of milk.
 83 Although the Panel did not express
any firm view on this issue, we see no error in the Panel's treatment of this question.
3. Imputed Costs
99. Canada objects to the inclusion, in the COP standard, of an imputed amount for the costs of
the producer's family labour and management, and for the costs of owner's equity. Canada contends
that, as the producer does not incur a cash cost for these items, they are not relevant because the COP
standard does not include "non-monetary" costs.
 84 Rather, Canada says, these items are rewarded by
any profits earned if revenues from milk sales exceed costs.
100. The Panel did not find that these imputed costs are to be included in the COP standard nor
that they are to be excluded from it. Instead, the Panel examined the evidence from the perspective of
these two positions, and found against Canada under each of them. 85

83We consider that it may be appropriate for the industry-wide cost of production figure to be
determined using a statistically valid sample of all producers.
85Panel Report, para. 5.90. We note, however, that the Panel also "recalled", in paragraph 5.126 of the
Panel Report, that these imputed costs "are properly to be included in a calculation of the average total cost of
production."

101. In examining this issue, we recall that the notion of "payment", in Article 9.1(c), covers
transfers of economic resources, irrespective of the means by which the resources are transferred.
Thus, the transfer may be effected in monetary form or equally by a transfer of goods or services for
less than full value.
 86
102. In these proceedings, the purpose of the COP standard is precisely to determine whether
supplies of CEM involve payments-in-kind that are made in a form other than money. If the COP
standard were confined solely to cash costs, as Canada argues, this would overlook the possibility of
"payments" being made in the form of non-cash resources invested in the production of milk. Thus,
the COP standard must cover all of the economic resources invested in the production of milk and
which may be transferred, irrespective of whether the resources involve an actual cash cost.
103. We are satisfied that any labour or management services provided by the farmer's family to
the dairy enterprise are relevant economic resources invested in the production of milk and must be
included in the COP standard. For the dairy farmer, and his or her family, the investment of services
in the dairy enterprise has an economic cost, as those services cannot be put to an alternative
remunerative use. We observe that both the United States and New Zealand submitted evidence to the
Panel in support of the view that, from the perspective of economic theory, any labour and
management services provided to an enterprise involve such an economic "opportunity" cost.
 87
Moreover, we believe that remuneration of family labour and management services is not part of the
profits of the dairy farm. Rather, profits are the proceeds remaining after all costs, including such
salary costs, have been accounted for.
104. The same is also true of any equity the owner invests in the dairy enterprise. The allocation
of such capital is, clearly, an investment of economic resources and carries an economic opportunity
cost to the owner because the capital cannot simultaneously be invested elsewhere.
 88 Again, the
profits of the dairy enterprise are the proceeds after all costs, including the cost of equity, have been
accounted for.

86Appellate Body Report, Canada – Dairy, paras. 107-112.
87Exhibit NZ-23 submitted by New Zealand to the Panel; Exhibit US-35 submitted by the United
States to the Panel.
88The documentary evidence submitted by New Zealand and the United States is equally supportive of
the view that, in economic theory, investment of equity involves an economic opportunity cost. ( Ibid.)

105. Moreover, it would be incongruous if the costs of family labour and management were
excluded from the COP standard when provided by family, but included when provided by others. 89
Likewise, it would be curious if the cost of capital, of which equity is one type, were excluded from
the COP standard when capital is provided thr ough the owner's equity, but included when it is
provided through, for instance, debt, merely because the cost of debt is expressed in recurring cash
outlays for interest payments. In each case, the dairy enterprise is incurring an economic cost and that
cost should be appropriately reflected in the costs of production.
106. Accordingly, we find that any failure to include in the COP standard the costs of family
labour and management, or of owner's equity, would understate the costs of milk production, and may
lead to a non-monetary "payment" going undetected.
107. Although it is clear that the COP standard includes all economic costs, even if they are non-
cash costs, we acknowledge that a specific value cannot be as readily ascribed to non-cash costs as it
can to cash costs. However, we do not believe, as suggested by Canada, that this practical difficulty
precludes the application of an objective COP standard.
108. In some situations, it may be appropriate for a panel to value non-monetary costs using a
methodology set forth in a Member's Generally Accepted Accounting Principles ("GAAP"). In that
respect, we observe that Canada did not contes t the amounts the Canadian Dairy Commission (the
"CDC") ascribed to depreciation using the rules in Canadian GAAP.
 90 However, although GAAP
provide an objective valuation methodology for some non-monetary costs, they may not address all
such costs. 91 If GAAP rules do not provide an appropriate basis for valuing a particular cost, a panel
should attempt to determine a value for relevant non-monetary costs using an objective methodology
that is reasonable in the circumstances. Clearly, a panel must base itself on the evidence before it,
applying the applicable rules on burden of proof.

89We note that, according to the Canadian Dairy Commission Handbook (" CDC Handbook "), family
labour and management is treated as an imputed, non-cash cost, "regardless of whether or not the family
member is paid for his/her labour". ( CDC Handbook , p. 26, Exhibit NZ-4 submitted by New Zealand to the
Panel; Exhibit US-22 submitted by the United States to the Panel) Thus, in some cases there may be an actual
cost for family labour and management which is excluded by the CDC and replaced by an imputed cost using
the CDC's methodology. Canada's argument would, in fact, exclude both an actual cost incurred by the dairy
enterprise and an imputed cost. We note also that the CDC Handbook defines a family member in broad terms
to include: "the producer, the producer's spouse, children, brothers, sisters, sons-in-law, daughters-in-law and
parents." (CDC Handbook, p. 25, principle 8, Exhibit NZ-4 submitted by New Zealand to the Panel)
90CDC Handbook , pp. 23-24, Exhibit NZ-4 submitted by New Zealand to the Panel; Exhibit US-22
submitted by the United States to the Panel.
91We note that GAAP typically provide accounting rule s for corporations, often publicly listed, and not
for smaller family-run enterprises. As such, many countries' GAAP may not provide rules on imputed costs for
family labour, management, or owner's equity.

109. We note that New Zealand and the United States submitted evidence to the Panel in the form
of CDC data that includes an imputed amount for the costs of family labour and management, and of
owner's equity. The methodologies the CDC used to arrive at the costs for these items are set forth in
the CDC Handbook and seem, to us, to be perfectly reasonable.
 92 In our view, the Panel did not err
in placing reliance upon these data and the methodologies underlying them. Although we
acknowledge that other equally reasonable valuation methods may exist, we note that Canada did not
submit, pursuant to Article 10.3 of the Agreement on Agriculture, evidence of any alternative method
for valuing these inputs.
110. We, therefore, find that the COP standard for determining whether "payments" exist, under
Article 9.1(c) of the Agreement on Agriculture , includes all monetary and non-monetary economic
costs of production, such as the costs of family labour and management, and of owner's equity. We
see no error in the Panel's approach to this issue.
4. Selling Costs
111. Canada suggests that, for purposes of Article 9.1(c) of the Agreement on Agriculture , only
the farm-based costs of producing milk should be taken into account in the COP standard, so that the
costs of selling milk—such as quota, transport, marketing, and administrative costs—would be
excluded. 93
112. The Panel did not find that these selling costs are to be included in the COP standard, nor that
they are to be excluded from it. Instead, the Panel examined the evidence from the perspective of
both positions and found against Canada under each of them.
 94
113. We recall that the COP standard represents the producer's investment of economic resources
in milk and, hence, in these proceedings, the proper value of the milk to the producer. 95 In our view,
costs incurred by the producer in selling milk are as much a part of the economic resources the

92CDC Handbook , pp. 26-31, Exhibit NZ-4 submitted by New Zealand to the Panel; Exhibit US-22
submitted by the United States to the Panel.
93Although Canada considers that these costs should be excluded from the COP standard, Canada also
considers that sales proceeds referable to transport, marketing, and administration inputs should be deducted
from the sales price in comparing the COP standard to CEM prices. (Canada's appellant's submission, para. 64)
As Canada stated at the oral hearing, the result is, therefore, the same as if these costs were included in the
COP standard and included in the price. However, leaving asid e the practical implications of Canada's
position, the legal issue remains whether it is appropriate for selling costs to be included in the COP standard.
94Panel Report, para. 5.90. We note, however, that the Panel also "recalled", in paragraph 5.126 of the
Panel Report, that the cost of quota, and transport, marketing and administrative costs "are properly to be
included in a calculation of the average total cost of production."
95Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 96.

producer invests in the milk as are farm-based production costs. Indeed, the costs incurred to make
sales are a vital part of the process by which the producer earns revenues through producing milk. If
the producer sells milk at a price sufficient to cover only the farm-based production costs, it transfers
to the processor any resources invested in selling th e milk, such as the value of transport, marketing,
and administration. There would, in such circumstances, be a "payment" of the value of these
additional selling costs. Accordingly, these cost s must be included in the COP standard in the
comparison with the sales price of CEM.
114. In addition, we can see no reason to exclude the cost of quota from the COP standard. On the
contrary, to the extent that the acquisition or retention of quota involves economic costs for the dairy
producer, these costs should be reflected in the COP standard. In that respect, we are not persuaded
by Canada that the cost of quota should be exclud ed from the COP standard because it relates solely
to the domestic market. In the first Article 21.5 proceedings, we held that the COP standard must be
determined for "all milk, whether destined for domestic or export markets".
 96 Thus, in principle, the
costs of quota form part of the COP standard. It remains, however, to decide how quota costs are to
be incorporated into the standard.
115. In these second Article 21.5 proceedings, there is very little evidence on record relating to the
cost of acquiring or retaining quota, and the Panel did not make any specific findings relating to the
cost of quota. Instead, in the absence of evidence, the Panel made a general statement that, "[i]f
anything, additions reflecting the cost of quota" should be made to the CDC data on costs of
production. 97 In other words, the Panel believed that the CDC data understated the real costs of
production because they did not include an amount for the cost of quota. But the Panel was unable to
quantify the addition it believed should be made. As the Panel had found that the evidence before it
supported a finding that CEM sales are, on average, made at a price below the COP standard, this
general remark did not have any bearing on the Panel's conclusion.
 98 In the light of this fact, and in
the absence of evidence relating to quota, we make no determination as to how, precisely, the cost of
quota should be reflected in the COP standard.
116. Accordingly, we find that any transport, marketing, and administrative costs are to be
included in the COP standard applied under Article 9.1(c), as are any costs of acquiring and retaining
quota. The Panel committed no error of law in its assessment of these costs.

96Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US) , para. 96. (original
italics; underlining added)
97Panel Report, para. 5.85.
98Ibid., para. 5.89.

5. Assessment of Evidence
117. We recall that the Panel examined the evidence from two different perspectives—that is,
using both the complaining Members' and Canada's proposed COP standards. The Panel found that,
under both of these standards, "payments" were being made through the supply of CEM.
 99
118. Canada submits that the Panel erred in its assessment of the evidence by placing a burden on
Canada that it "cannot possibly be expected to meet." 100 Canada's argument relates to the Panel's
assessment of the evidence using Canada's proposed COP standard, that is, a COP standard applied
on an "individual", as opposed to an "industry-wide" basis, and excluding from the COP standard,
the costs of family labour and management, and of owner's equity, and also quota, transport,
marketing, and administrative costs.
119. We have held that the COP standard is to be determined on an industry-wide basis and that it
includes all the costs that Canada proposed be excluded, as they involve economic resources invested
in the production of milk.
 101 As such, the Panel's examination of the evidence from Canada's
perspective is rendered moot, because it is based on a legal standard that we have found to be the
incorrect one. Any review of the Panel's treatment of the evidence must, instead, focus on its
examination of the evidence which included the various costs Canada proposed to exclude. That is,
we must review the Panel's comparison of the price of CEM with the COP standard including the
costs of family labour and management, and of owner's equity, and also quota, transport, marketing,
and administrative costs.
120. The evidence submitted to the Panel by the complaining Members, in the form of CDC data,
included amounts for all these costs, other than quota . According to this ev idence, the industry-wide
cost of production figure for the year 2000 was C$57.27 per hectolitre ("hl"), and for 2001, it was
C$58.12/hl. The average prices for CEM for these periods were C$29/hl and C$31.72/hl,
respectively.
 102 Thus, as the Panel found, on an industry-wide basis, CEM prices are significantly
below the COP standard. On the basis of this evidence, the Panel found that there was a prima facie
case that "payments" are being made. 103 Moreover, under Article 10.3 of the Agreement on
Agriculture, the burden of proof was on Canada to establish the contrary. The Panel found that

99Panel Report, para. 5.89.
101Supra, paras. 110 and 116.
102Panel Report, para. 5.33; Canada's response to Question 61 posed by the Panel during the Panel
proceedings.
103Panel Report, para. 5.89.

Canada had not satisfied that burden. 104 We can see no error in the Panel's assessment of the
evidence. 105
6. Conclusion on "Payments" under Article 9.1(c)
121. For all these reasons, we uphold the Panel's finding, in paragraph 5.89 of the Panel Report,
that the supply of CEM, by producers to processors, involves "payments" within the meaning of
Article 9.1(c) of the Agreement on Agriculture.
B. "Financed by Virtue of Governmental Action"
122. We turn now to the second element of Canada's appeal of the Panel's findings under
Article 9.1(c) of the Agreement on Agriculture—whether the Panel erred in finding that "payments",
made on the sale of CEM, are "financed by virtue of governmental action".
123. The Panel recalled that there must be a "demonstrable link" between governmental action and
the financing of "payments".
 106 The Panel proceeded to examine several actions of the Canadian
government in regulating the supply of domestic milk and CEM. It concluded that New Zealand and
the United States had made out a prima facie case that a demonstrable link exists between these
Canadian governmental actions and the financing of CEM payments. Further, the Panel found that
Canada had failed to establish, pursuant to Article 10.3 of the Agreement on Agriculture, that these
governmental actions were not demonstrably linked to the financing of the payments.
 107
124. On appeal, Canada argues that the Panel erred under Article 9.1(c) of the Agreement on
Agriculture, in particular by finding that a "demonstrable link" exists between Canadian
governmental action and the financing of CEM payments. Canada claims that it has removed
government action from "every stage of the export transaction" and that producers and processors
"freely choose to enter into export transactions".
 108 Therefore, Canada argues that no demonstrable
link exists between governmental action and financing of CEM payments.

104Panel Report, para. 5.89.
105Pursuant to Article 11 of the DSU, a panel must make an objective assessment of the facts. As such,
a panel is the trier of facts, responsible for evaluating the credibility and weight of the evidence. As we have
stated, we will interfere with a panel's assessment of the evidence only if the panel has exceeded the bounds of
its discretion as trier of facts. (Appellate Body Report, US – Wheat Gluten, para. 151)
107Ibid., paras. 5.133-5.135.
108Canada's appellant's submission, paras. 74 and 101.

125. Article 9.1(c) of the Agreement on Agriculture provides:
Export Subsidy Commitments
1. The following export subsidies are subject to reduction
commitments under this Agreement:
…
(c) payments on the export of an agricultural product that are
financed by virtue of governmental action, whether or not a charge on
the public account is involved, including payments that are financed
from the proceeds of a levy imposed on the agricultural product
concerned or on an agricultural product from which the exported
product is derived; (emphasis added)
126. The phrase "financed by virtue of governmental action" has three distinct elements—
"governmental action"; "by virtue of "; and "financed"—which we will address in turn.
127. As regards "governmental action", we held in the first Article 21.5 proceedings that "the text
of Article 9.1(c) does not place any qualifications on the types of 'governmental action' which may be
relevant under Article 9.1(c)." 109 Instead, the provision gives but one example of governmental
action that is "included" in Article 9.1(c)—however, this example is merely illustrative. 110
Accordingly, we stated that Article 9.1(c) "embraces the full-range" of activities by which
governments "
 'regulate', 'control' or 'supervise' individuals". 111 In particular, we said that
governmental action "regulating the supply and price of milk in the domestic market" might be
relevant "action" under Article 9.1(c).
 112 Moreover, the governmental action may be a single act or
omission, or a series of acts or omissions.
128. We observe that Article 9.1(c) does not require that payments be financed by virtue of
government "mandate", or other " direction". Although the word "action" certainly covers situations
where government mandates or directs that payments be made, it also covers other situations where
no such compulsion is involved.
 113

109Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 112.
110The example given is "payments that are financed from the proceeds of a levy imposed on the
agricultural product concerned or on an agricultural product from which the exported product is derived".
111Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 112.
112Ibid.
113Article 9.1(c) of the Agreement on Agriculture may be contrasted with Article 9.1(e) of the
Agreement on Agriculture , as well as with Article 1.1(a)(1)(iv) of the SCM Agreement, and items (c), (d), (j),
and (k) of the Illustrative List of Export Subsidies (the "Illustrative List") of the SCM Agreement . In these
provisions, some kind of government mandate, direction, or control is an element of a subsidy provided through
a third party.

129. Although the term "governmental action", when read in isolation, is somewhat open-ended,
perhaps even abstract, the words "by virtue of " clarify further the meaning of this term. In the first
Article 21.5 proceedings, we opined:
The words "by virtue of " indicate that there must be a demonstrable
link between the governmental action at issue and the financing of
the payments, whereby the payments are, in some way, financed as a
result of, or as a consequence of, the governmental action.
 114 (original
italics)
130. The words "by virtue of ", therefore, express the relationship between "governmental action"
and the "financing" of payments for the purpose of Article 9.1(c). The essence of that relationship is
the "nexus" or "link" between "action" and "financing".
131. Thus, although Article 9.1(c) extends, in principle, to any "governmental action", not every
governmental action will have the requisite nexus to the financing of payments. In the first
Article 21.5 proceedings, we observed that "[g]overnments are constantly engaged in regulation of
different kinds in pursuit of a variety of objectives."
 115 Yet, we went on to say that regulation that
merely enables payments to occur will not suffice for those payments to be regarded as "financed by
virtue of governmental action". We stated:
[Where regulation merely enables payments to occur], the link
between the governmental action and the financing of the payments
is too tenuous for the "payments" to be regarded as " financed by
virtue of governmental action" … within the meaning of
Article 9.1(c). Rather, there must be a tighter nexus between the
mechanism or process by which the payments are financed …
 116
(original italics)
132. This brings us to the meaning of the word "f inancing". The word refers generally to the
mechanism or process by which financial resources are provided to enable "payments" to be made.
The word could, therefore, be read to mean that government itself must provide the resources for
producers to make payments. However, Article 9.1(c) expressly precludes such a reading, as it states
that "payments" need not involve "a charge on the public account". This is borne out by the fact that
the text indicates that "financing" need only be "by virtue of governmental action", rather than "by
government" itself. Article 9.1(c), therefore, contemplates that "payments may be financed by virtue

114Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 113.
115Ibid., para. 115.
116Ibid.

of governmental action even though significant aspects of the financing might not involve
government." 117 Indeed, as we have said, payments may be made, and funded, by private parties. 118
133. The word "financing" must, nonetheless, be given meaning. Accordingly, even if government
does not fund the payments itself, it must play a sufficiently important part in the process by which a
private party funds "payments", such that the requisite nexus exists between "governmental action"
and "financing".
134. These general remarks illustrate well that "[i]t is extremely difficult … to define in the
abstract the precise character of the required link between the governmental action and the financing
of the payments, particularly where payments-in-kind are at issue."
 119 In each case, the alleged link
must be examined taking account of the particular character of the governmental action at issue and
its relationship to the payments made. 120
135. With this mind, we turn to the facts of this dispute. We recall that we have described the key
features of the Canadian regulatory system in paragraphs 12-14 of this Report. 121
136. We have also upheld the Panel's finding that producers make "payments", under Article 9.1(c)
of the Agreement on Agriculture , to processors through sales of CEM at prices that are below the
COP standard. As a result, producers' sales revenues do not recoup all of the costs associated with
producing and selling CEM. As this short-fall in revenues must be "financed" from some other
source, sales of CEM necessarily involve the "financing" of "payments". The crucial question is the
source of that financing and, in particular, whether the financing occurs "by virtue of governmental
action".
137. The Panel considered that "a significant percentage" of Canadian milk producers are able to
cover the entirety of fixed and variable costs of production through in-quota sales of domestic milk.
As a result, the Panel opined, these producers can afford to make export sales at marginal cost.
 122 The
Panel found that governmental action regulating the domestic milk market "cross-subsidizes many
sales that otherwise would not be made or would at least constitute sales at a loss."
 123

117Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 114.
118Supra, para. 87.
119Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 115.
120Ibid., para. 115.
121See also Panel Report, paras. 2.1-2.4.
122Ibid., para. 5.128.
123Ibid., para. 5.127.

138. We note that CEM is produced almost exclusively by the same producers who supply milk to
the domestic market. 124 It is not contested that these producers use the same production facilities to
produce domestic and export milk—that is, the same land, cattle, buildings, machinery, milking
facilities, and so on. Indeed, in some provinces, even after production, both regulatory classes of milk
have common storage and transportation facilities.
 125 There is, in other words, a single line of
production for all milk, whatever its destination market.
139. Where fungible goods, such as milk, are produced using a single line of production, but sold
in two different markets, the fixed costs of production are, in principle, shared between sales revenues
from both markets. However, in the event that one of the two markets offers much higher revenues, a
disproportionately large part, possibly even all, of the shared fixed costs may be borne by sales made
in the more remunerative market.
140. Where sales in the more remunerative market bear more than their relative proportion of
shared fixed costs, sales in the other market do no t need to cover their relative proportion of the
shared fixed costs in order to be profitable. 126 Rather, these sales can be made profitably below the
average total cost of production. If the more remunerative sales cover all fixed costs, sales in the
other market can be made profitably at any price a bove marginal cost. In these situations, the higher
revenue sales effectively " finance" a part of the lower revenue sales by funding the portion of the
shared fixed costs attributable to the lower priced products.
141. In Canada, the domestic price of milk is fixed by a government agency—the CDC—on the
basis of an annual survey of producers' costs of production. The CDC has a statutory mandate to
ensure that, through the administered price, a "fair return" is secured for "efficient producers". The
CDC sets this administered price on the basis of data covering 70 percent of producers, such that these
70 percent of producers can, on average, cover all of their costs of production, including all fixed

124According to Canada, approximately 100 milk producers produce CEM without, at the same time,
holding a domestic quota. (Canada's response to Questio n 2(c) posed by the Panel during the Panel proceedings,
confirmed by Canada's response to questioning at the oral hearing) These 100 producers represent
approximately 0.5% of all 19,000 Canadian milk producers and 1.25% of all 8000 CEM producers. (Panel
Report, paras. 3.70 and 5.55) Moreover, the export market represents only 3.62 percent, by volume, of the total
Canadian milk production. (Canada's response to questioning at the oral hearing)
125See, for instance, the Agreement on Commercial Milk Export between the British Columbia Milk
Producers Association, the Mainland Dairymen's Associ ation, and the British Columbia Dairy Council, p. 2,
Exhibit US-21 submitted by the United States to the Panel.
126Even if sales in the more remunerative market do not cover all of the shared fixed costs, they may
bear a higher relative proportion of those costs, such that sales in the less remunerative market can be made at a
price below the average total cost of production, because these sales do no t need to cover their entire relative
proportion of shared fixed costs.

costs, through domestic sales of milk. 127 Moreover, for other producers, domestic sales will cover a
significant part, if not all, of the fixed costs. This suggests, to us, that a large proportion of producers
can finance the sale of CEM at a price that is below the COP standard as a result of participation in
the domestic market .
 128 In that respect, we note also that the domestic milk market represents 96.4
percent, by volume, of total Canadian milk production, with export production representing only 3.6
percent, by volume.
 129
142. We observe that, although there is a large proportion of producers that could sell CEM below
the COP standard, the proportion of producers who have actually made at least one CEM sale is
around 40 percent of all producers.
143. In these circumstances, we agree with the Panel that the evidence indicates that a "significant
percentage" of producers are "likely" to make sales of CEM at below the costs of production as a
result of highly remunerative in-quota sales in the domestic market. For these producers, domestic
sales are likely to "finance" payments made on the sale of CEM. Although the Panel's finding is
based on "likelihood", this likelihood seems, to us, to be rather high. Any producer whose fixed costs
have been, in large part, covered by domestic sales, and who has sufficient capacity to produce for the
export market, has a powerful profit incentive to sell CEM at a competitive export price, even if that
price is below the average total cost of production, as long as the price is above marginal costs of
production. In any event, we recall that, pursuant to Article 10.3 of the Agreement on Agriculture,
Canada bears the burden of proving that sales of CEM do not involve the granting of export subsidies.
144. It falls now to consider the role of the Canadian government in financing payments made on
the sale of CEM. We have agreed with the Panel that a significant percentage of producers are likely
to finance sales of CEM at below the costs of production as a result of participation in the domestic
market. Canadian "governmental action" controls virtually every aspect of domestic milk supply and
management.
 130 In particular, government agencies fix the price of domestic milk that renders it

127Panel Report, para. 5.128.
128In addition to the CDC Handbook , the Panel also referred to newspaper articles submitted by
New Zealand to support its view that a significant proportion of producers covers their fixed costs through
domestic sales. (Panel Report, para. 5.128; Exhibit NZ-7 submitted by New Zealand to the Panel) In the two
newspaper articles, the President of Dairy Farmers Canada and the Chairman of Dairy Farmers Ontario asserted,
respectively, that only 25 percent and 39 percent of producers would cover all their costs at the price fixed by
the CDC. At the oral hearing, Canada cautioned that such newspaper opinions should be treated "carefully". In
any event, we note that even these figures tend to indicate that a large proportion of producers covers most, if
not all, of their fixed costs through in-quota domestic sales.
129Canada's response to questioning at the oral hearing.
130We recall that certain aspects of the supply and management of milk in Canada were examined in the
original proceedings in this dispute. In those proceed ings, we found that the agencies managing the supply of
milk were "government" agencies. (Appellate Body Report, Canada – Dairy, para. 118)

highly remunerative to producers. Government action also controls the supply of domestic milk
through quota, thereby protecting the administered price. The imposition by government of financial
penalties on processors that divert CEM into the domestic market is another element of governmental
control over the supply of milk. Further, the degree of government control over the domestic market
is emphasized by the fact that government pools, allocates, and distributes revenues to producers from
all domestic sales. Finally, governmental action also protects the domestic market from import
competition through tariffs.
 131
145. In our view, the effect of these different governmental actions is to secure a highly
remunerative price for sales of domestic milk by producers. In turn, it is due to this price that a
significant proportion of producers covers their fixed costs in the domestic market and, as a result, has
the resources profitably to sell export milk at prices that are below the costs of production.
146. Accordingly, we agree with the Panel that "governmental action" in the domestic market
plays a critical part in the "financing" of payments made by a significant percentage of producers on
the sale of CEM. As such, we agree with the Panel that payments made through the supply of CEM at
below the COP standard are financed by virtue of this governmental action.
 132 We also agree with the
Panel that Canada failed to establish the contrary, pursuant to Article 10.3 of the Agreement on
Agriculture.
147. We do not agree with Canada that the circumstances indicate that the Canadian government
has merely created a regulatory framework whereby it has enabled producers to sell CEM at prices
that are below the costs of production. Certainly, producers decide for themselves whether and when
to sell CEM. However, governmental action in the domestic market goes further than simply creating
a regulatory environment in which producers choose to make export payments using their own
resources. Rather, as we have said, Canadian go vernmental action is instrumental in providing a
significant percentage of producers with the resources that enable them to sell CEM at below the
costs of production.

131For instance, in its Schedule, Canada has established a tariff quota of 64,500 tonnes for fluid milk
(tariff headings 0401.10.10 and 0401.20.10) for cross-border purchases imported by Canadian consumers, with
an in-quota tariff rate of 7.5 percent since 2001; outside this tariff quota, since 2001, Canada's bound tariff is
241.3 percent, but not less than C$34.5/hl. For yogurt (tariff heading 0403.10), the tariff quota is 332 tonnes
and is limited to yogurt in retail-sized containers only; outside this quota, since 2001, the applicable bound
tariff rate is 237.5 percent, but not less than 46.6¢/kg. "Fresh (unripened or uncured) cheese" (tariff heading
0406.10) falls under a tariff quota of 20,411,866 tonnes; outside this quota, since 2001, the applicable bound
tariff rate is 245.6 percent, but not less than 451.1¢/kg.
132Panel Report, paras. 5.133-5.135.

148. Canada also objects that this reasoning brings "cross-subsidization" under Article 9.1(c) of the
Agreement on Agriculture . 133 We have explained that the text of Article 9.1(c) applies to any
"governmental action" which "finances" export "payments". The text does not exclude from the scope
of the provision any particular governmental action, such as regulation of domestic markets, to the
extent that this action may become an instrument for granting export subsidies. Nor does the text
exclude any particular form of financing, such as "cross-subsidization". Moreover, the text focuses on
the consequences of governmental action ("by virtue of which") and not the intent of government.
Thus, the provision applies to governmental action that finances export payments, even if this result is
not intended. As stated in our Report in the first Article 21.5 proceedings, this reading of
Article 9.1(c) serves to preserve the legal "distinction between the domestic support and export
subsidies disciplines of the Agreement on Agriculture ".
 134 Subsidies may be granted in both the
domestic and export markets, provided that the disciplines imposed by the Agreement on the levels of
subsidization are respected. If governmental action in support of the domestic market could be
applied to subsidize export sales, without respec ting the commitments Members made to limit the
level of export subsidies, the value of these commitments would be undermined. Article 9.1(c)
addresses this possibility by bringing, in some circumstances, governmental action in the domestic
market within the scope of the "export subsidies" disciplines of Article 3.3.
149. In our view, the nexus between the Canadian governmental actions in regulating the domestic
market and the financing of payments made on the sale of CEM is sufficient, on its own, for us to
uphold the Panel's finding that these payments are financed "by virtue of
 " governmental action.
However, we note that, besides these actions, the Panel also relied on other forms of governmental
action in support of its conclusion on this issue.
 135 The first of these was that processors are exempt
from paying the higher domestic price for milk when they purchase CEM. 136 We do not believe that
this action influences the "financing" of payments by the producer. Certainly, this action explains
why the processor of CEM is not required to pay the higher domestic price for CEM. However,
the mere fact that the processor is not obliged to buy CEM at the domestic price does not demonstrate
a link between this exemption and the financing of payments by the producer on the sale of CEM.
The exemption is, in short, not linked to the mechanism by which the producer funds the payments.

133The Panel used this term to describe the fact that sales revenues from one market—the domestic
market—finance a portion of the costs associated with sales made in another market—the CEM market. (Panel
Report, paras. 5.127, 5.130, and 5.134)
134Appellate Body Report, Canada – Dairy (Article 21.5 – New Zealand and US), para. 90.
135Panel Report, para. 5.134.
136Ibid., paras. 5.115-5.116.

150. The second other form of governmental action relied on by the Panel was "the prohibition on
the diversion of CEM back into the domestic regulated market". 137 We have already mentioned this
factor in our analysis of governmental action. 138
151. The final governmental action relied on by the Panel was the requirement for producers to
pre-commit to sell CEM. The Panel found that this requirement creates "an additional incentive" to
sell a larger quantity of CEM than would be the case if producers could decide to sell to that market
"ex post
 ". 139 Although this may be the case, we also consider it possible that producers are able to
make a reasonably accurate prediction of production levels, particularly as pre-commitment occurs on
a 30-day basis.
 140 Further, we think producers are just as likely to err on the side of caution to ensure
that CEM sales do not prejudice their ability to exhaust their quota entitlement to sell milk at the
higher domestic price. In the light of these doubts, we attach no weight to the pre-commitment
requirement.
152. Before concluding, we wish to comment on Canada's arguments concerning the
approximately 100 producers out of the 8,000 who sell CEM, and out of the total of 19,000 producers
that do not participate in the domestic market at all and sell solely CEM.
 141 Canada argues that the
Panel erred in finding that, for these producers, sales of CEM involve payments "financed by virtue of
governmental action". We do not believe that it is necessary for us to make any findings regarding
these 100 producers. The complaint made by New Zealand and the United States is that Canada has
acted inconsistently with its export subsidy commitments under the Agreement on Agriculture .
Canada may act inconsistently with these commitments, as we have found, even if some producers
never make payments financed by virtue of governmental action.
153. We also wish to emphasize that we do not suggest that Canada's domestic supply
management system is inconsistent with Canada's obligations under the covered agreements and,
specifically, the Agreement on Agriculture . The consistency of Canada's domestic milk supply
management system is not at issue in these proceedings. However, pursuant to Articles 3.3, 8,
and 9.1(c) of the Agreement on Agriculture , Canada must ensure that it confines, to its export
subsidy reduction commitment levels, any export "payments" which are "financed by virtue of
 " the
governmental action Canada takes to regulate the domestic milk market.

137Panel Report, paras. 5.117 and 5.134.
138Supra, para. 144.
139Panel Report, para. 5.130.
140Canada's response to questioning at the oral hearing.
141See supra, footnote 124.

154. In conclusion, therefore, we uphold the Panel's finding, in paragraph 5.135 of the Panel
Report, that the supply of CEM, by producers to processors, involves payments which are "financed
by virtue of governmental action", within the meaning of Article 9.1(c) of the Agreement on
Agriculture.
C. Conclusion on Article 9.1(c) of the Agreement on Agriculture
155. We have upheld the Panel's finding that the supply of CEM involves "payments" on the
export of dairy products and also its finding that these payments are "financed by virtue of
governmental action". Accordingly, we uphold the Panel's finding, in paragraph 5.136 of the Panel
Report, that the supply of CEM involves export subsidies under Article 9.1(c) of the Agreement on
Agriculture.
156. In consequence, we also uphold the Panel's conclusion, in paragraph 6.1 of the Panel Report,
that, through the combination of the supply of CEM and the operation of Special Milk Class 5(d),
Canada has acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on
Agriculture.
VII. Article 10.1 of the Agreement on Agriculture— "Export Subsidies"
157. Canada also appeals the Panel's alternative finding, in paragraph 5.165 of the Panel Report,
that, if the CEM scheme does not involve export subsidies under Article 9.1(c) of the Agreement on
Agriculture, it nevertheless constitutes export subsidies under Article 10.1 of that Agreement.
 142 In
making this alternative finding, the Panel recalled that Article 10.1 of the Agreement on Agriculture
is residual in character to Article 9.1 of the Agreement on Agriculture and that a measure cannot
simultaneously be an export subsidy under both Article 9.1 and Article 10.1. 143 The Panel stated that
its alternative finding under Article 10.1 of the Agreement on Agriculture would be relevant only if
we were to reverse its finding that the CEM scheme falls within Article 9.1(c) of that Agreement. 144
158. As we have concluded that the CEM scheme involves export subsidies under Article 9.1(c) of
the Agreement on Agriculture , those subsidies cannot, by definition, simultaneously be export
subsidies under Article 10.1. Therefore, the condition on which the Panel premised its alternative
finding under Article 10.1 of the Agreement on Agriculture does not arise. In these circumstances,

142See also Panel Report, paras. 5.174 and 6.1.
143See ibid., para. 5.140, referring to Appellate Body Report, Canada – Dairy (Article 21.5 – New
Zealand and US), para. 121.
144See ibid., paras. 5.141 and 5.174.

both the Panel's reasoning and its finding under Article 10.1 of the Agreement on Agriculture are
moot and of no legal effect. There is, therefore, no reason for us to rule upon Canada's appeal of the
Panel's finding under Article 10.1, nor to make any finding under this provision.
VIII. Findings and Conclusions
159. For the reasons set out in this Report, the Appellate Body:
(a) reverses the Panel's interpretation of Article 10.3 of the Agreement on Agriculture in
paragraph 5.19 of the Panel Report, according to which a complaining Member would
be required to make out a prima facie case in support of all aspects of its claims
under Articles 3.3, 8, 9.1(c), and 10.1 of the Agreement on Agriculture , but holds
that this error did not vitiate the Panel's findings under Articles 3.3, 8, 9.1(c), and 10.1
of that Agreement;
(b) upholds the Panel's finding, in paragraphs 5.89 and 5.135 of the Panel Report, that
Canada, through the combination of the supply of CEM and the operation of Special
Milk Class 5(d), has acted inconsistently with its obligations under Article 3.3 and
Article 8 of the Agreement on Agriculture by providing export subsidies listed in
Article 9.1(c) of that Agreement in excess of the quantity commitment levels
specified in Canada's Schedule; and
(c) declines to rule on the Panel's alternative finding under Article 10.1 of the Agreement
on Agriculture in paragraph 5.165 of the Panel Report, as, in the light of the
Appellate Body's finding in subparagraph (b) above, that alternative finding is moot
and of no legal effect.
160. The Appellate Body recommends that the DSB request that Canada bring its measures found
in this Report, and in the Panel Report as modified by this Report, to be inconsistent with its
obligations under the Agreement on Agriculture, into conformity with that Agreement.

Signed in the original at Geneva this 5th day of December 2002 by:
Luiz Olavo Baptista
Presiding Member
_________________________ _________________________
Giorgio Sacerdoti Yasuhei Taniguchi
Member Member