CANADA – MEASURES AFFECTING THE IMPORTATION OF MILK AND THE EXPORTATION OF DAIRY PRODUCTS RECOURSE TO ARTICLE 21.5 OF THE DSU BY NEW ZEALAND AND THE UNITED STATES AB-2001-6
Document: AB-2001-6 Report of the Appellate Body
Date: 3 December 2001
Document codes: WT/DS103/AB/RW; WT/DS113/AB/RW
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
RECOURSE TO ARTICLE 21.5 OF THE DSU
BY NEW ZEALAND AND THE UNITED STATES
AB-2001-6
Report of the Appellate Body

APPELLATE BODY
Canada – Measures Affecting the Importation of
Milk and the Exportation of Dairy Products
Recourse to Article 21.5 of the DSU by
New Zealand and the United States
Canada, Appellant
New Zealand, Appellee
United States, Appellee
European Communities, Third Participant
AB-2001-6
Present:
Taniguchi, Presiding Member
Abi-Saab, Member
Ganesan, 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 – 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 – Measures Affecting the Importation of Milk and the Exportation of Dairy
Products ("Canada – Dairy
 ") 2 were not consistent with Canada's obligations under the Agreement
on Agriculture and the Agreement on Subsidies and Countervailing Duties (the "SCM Agreement ").
2. In Canada – Dairy, the original panel and the Appellate Body found, inter alia, that
Canada had acted inconsistently with its obligations under Articles 3.3 and 8 of the Agreement on
Agriculture, through its scheme of Special Milk Classes 5(d) and 5(e), by providing "export
subsidies" within the meaning of Article 9.1(c) of that Agreement, in excess of the quantity
commitment levels specified by Canada in its Schedule of Commitments under the Marrakesh
Agreement Establishing the World Trade Organization (the " WTO Agreement "). On
27 October 1999, the DSB adopted the original panel and Appellate Body reports.

1WT/DS103/RW, WT/DS113/RW, 11 July 2001.
2The recommendations and rulings of the DSB resulted from the adoption, by the DSB, of the panel
report in Canada – Dairy, WT/DS103/R, WT/DS113/R (the "original panel report"), as modified by the
Appellate Body Report, WT/DS103/AB/R and Corr.1, WT/DS113/AB/R and Corr.1, both a dopted
27 October 1999. 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".

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 On 19 January 2001, Canada affirmed
that it would complete its implementation of the recommendations and rulings of the DSB by
31 January 2001.
 5
4. The measures taken by Canada to comply with the recommendations and rulings of the DSB
included the elimination of Special Milk Class 5(e) and the restriction of exports of dairy products
under Special Milk Class 5(d) to Canada's export subsidy commitment levels. Canada otherwise
maintained its pre-existing milk supply management scheme, including the establishment of an annual
Market Sharing Quota for industrial milk and its allocation to milk producers, as well as regulation of
supplies and prices of milk through Milk Classes 1 to 4 and Special Milk Classes 5(a) to 5(d).
 6
Canada also created a new class of domestic milk, Class 4(m), under which any over-quota milk could
be sold only as animal feed. In addition, Canada introduced a new category of milk for export
processing known as "commercial export milk" ("CE M"). Under pre-commitment contracts, that is,
contracts concluded in advance of production, Canadian producers can sell any quantity of CEM to
Canadian processors for export processing 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, and the revenues derived by the producer from sales of
CEM are collected directly by it without government involvement. However, if a processed dairy
product, which is produced using CEM, is sold on the domestic market, the processor is liable to
financial penalties for diverting the dairy product into the domestic market.
 7 The factual aspects of
the new scheme are set out in greater detail in the Panel Report. 8

3WT/DS103/10, WT/DS113/10.
4WT/DS103/13, WT/DS113/13.
5WT/DS103/12/Add.6, WT/DS113/12/Add.6.
6For a description of the pre-existing milk supply management scheme, see, Appellate Body Report,
Canada – Dairy, supra, footnote 2, paras. 6-16, and the original Panel Report, Canada – Dairy, supra,
footnote 2, paras. 2.1-2.66.
7Panel Report, para. 6.77.
8Ibid., paras. 3.1-3.9.

5. Taking the view that certain of the measures taken by Canada to comply with the
recommendations and rulings of the DSB were not consistent with its 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.
 9
6. 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. 10
Canada objected to the level of suspension proposed, and the matter was referred to arbitration,
pursuant to Article 22.6 of the DSU.
 11 However, the parties agreed to request the arbitrator to
suspend its work pending the outcome of the Article 21.5 proceeding. 12
7. Before the Panel, New Zealand and the United States claimed that Canada had acted
inconsistently with Articles 3.3, 8, 9.1(c) and 10.1 of the Agreement on Agriculture through the
creation of a CEM market and the continued operation of Special Milk Class 5(d). The United States
also claimed that through these measures, Canada had acted inconsistently with its obligations under
Articles 1.1 and 3.1 of the SCM Agreement. Before the Panel, Canada denied that the provision of
CEM involved export subsidies under either the Agreement on Agriculture or the SCM Agreement.
8. In its Report, 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, for the marketing year
2000/2001.
 13
9. 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." 14

9WT/DS103/16 and WT/DS113/16. Two of the three members of the Panel had previously served on
the original panel. Panel Report, para. 1.10 and the original Panel Report, para. 1.8.
10WT/DS103/17 and WT/DS113/17.
11WT/DS103/18 and WT/DS113/18.
13Panel Report, para. 7.1. Having found that Canada had acted inconsistently with its obligations under
Article 9.1(c) of the Agreement on Agriculture, the Panel declined to address the claims relating to Article 10.1
of that Agreement and to Articles 1.1 and 3.1 of the SCM Agreement. (Panel Report, paras. 6.88 and 6.102)
14Ibid., para. 7.3.

10. On 4 September 2001, 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
paragraph 4 of Article 16 of the DSU, and filed a Notice of Appeal pursuant to Rule 20 of the
Working Procedures for Appellate Review (the " Working Procedures "). On 14 September 2001,
Canada filed its appellant's submission.
 15 On 1 October 2001, New Zealand and the United States
each filed an appellee's submission. 16 On the same day, the European Communities filed a third
participant's submission. 17
11. The oral hearing in the appeal was held on 26 October 2001. The participants and the
European Communities, as third participant, presented oral arguments and responded to questions put
to them by the Members of the Division hearing the appeal.
II. Arguments of the Participants and Third Participant
A. Claims of Error by Canada – Appellant
1. Article 9.1(c) of the Agreement on Agriculture – "payments"
12. Canada appeals the Panel's finding that CEM sales by producers to processors constitute
"payments" within the meaning of Article 9.1(c) of the Agreement on Agriculture.
13. Canada relies upon the finding of the Appellate Body in Canada – Dairy that "payments"
under Article 9.1(c) are made to the recipient "[i]f goods or services are supplied … at reduced rates
(that is, at below market-rates)".
 18 In the present case, there is no such "payment", since the CEM
scheme does not involve any government control over the price of milk destined for export
processing, in contrast with the former scheme where the Canadian government was found to set
lower prices for export milk through the Special Milk Classes and price-pooling mechanisms.
Accordingly, the prices freely determined for CE M on a willing-buyer, willing-seller basis, outside
the domestic price classification system, are prices at "market-rates", and not prices below "market-
rates". The Panel's failure to consider the changes in market conditions as a result of the deregulation
of CEM thus amounts to an error of law.

15Pursuant to Rule 21 of the Working Procedures.
16Pursuant to Rules 22 and 23(3) of the Working Procedures.
17Pursuant to Rule 24 of the Working Procedures.

14. Canada further submits that in determining whether there was a "payment", the Panel
incorrectly used domestic regulated prices as the benchmark for comparison with the "market-
determined" prices of CEM. A benchmark analysis is neither appropriate nor necessary in a situation
where the alleged discounted price is a market-determined price. In Canada's view, it is not rational to
use as a benchmark a "government-regulated" price to establish the "trade-distorting potential" of a
"market-determined" price.
2. Article 9.1(c) of the Agreement on Agriculture – "financed by virtue of
governmental action"
15. Canada also appeals the Panel's finding that the "payments" were "financed by virtue of
governmental action", within the meaning of Article 9.1(c) of the Agreement on Agriculture.
16. According to Canada, the Panel erred by applying a standard "less stringent" than the one
contemplated by Article 9.1(c) of the Agreement on Agriculture. The ordinary meaning of the three
elements of Article 9.1(c), that is, "financed", "by virtue of ", and "governmental action", read
individually and collectively, support Canada's view that there should be a "strong affirmative and
positive linkage between the governmental action and the financing of the payments". 19 On the
contrary, the Panel's interpretation suggests that Article 9.1(c) applies even when government is
"merely involved" in export markets or where priv ate action is "simply encouraged" by government.
The Panel also misapplied the legal reasoning of the Appellate Body in Canada – Dairy where the
Appellate Body found that "'governmental action' [was] not simply involv ed; it [was], in fact,
indispensable to enable the supply of milk to processors for export, and hence the transfer of
resources, to take place."
 20 Under the new CEM scheme, where the government has deregulated the
export transactions, there is no "strong affirmative and positive linkage" between the governmental
action and the financing of the payments.
17. Canada argues that the "but for" test, applied by the Panel to determine whether the payments
are "financed by virtue of governmental action", overlooks the word "financed" and falls short of the
concept of "indispensability" referred to by the Appellate Body in Canada – Dairy. Canada submits
that the Panel interpreted the word "financed" merely to mean that a payment is "made".
 21 The word
"financed", in its ordinary meaning, requires that a government "provide[] funds" or "perform[]
functions of raising, furnishing or managing funds".
 22 Canada finds support for this interpretation in

19Canada's appellant's submission, paras. 7, 49 and 52.
22Ibid., paras. 10 and 49.

the levy example in Article 9.1(c), in the object and purpose of the Agreement on Agriculture, and in
the Appellate Body Report in Canada – Dairy.
18. Canada also submits that the Panel misread Article 9.1(c) to mean that payments need not be
"directly financed", provided that governments " establish the conditions which ensure that the
payment … takes place". 23 (emphasis in original) Even if this standard were applicable under
Article 9.1(c) of the Agreement on Agriculture, Canada submits that the CEM scheme would not fall
within its scope, since Canada has not taken any measure to "ensure" or "compel" the provision of
CEM to processors. CEM is provided by producers to processors of their own volition and at freely
negotiated prices.
19. Furthermore, in the view of Canada, the Panel should have used the SCM Agreement as
relevant context and interpreted the word "subsidy" as used in that Agreement. Canada argues that
the Agreement on Agriculture and the SCM Agreement should be interpreted consistently, to the
extent permitted by their wording, in order to determine whether subsidies are involved. In particular,
Canada refers to the concept of "financial contribution" as a "cornerstone" in the meaning of
"subsidy" under the SCM Agreement, and to the panel report in United States – Measures Treating
Exports Restraints as Subsidies ("US – Export Restraints")
 24 which provides an analysis of the fourth
kind of "financial contribution " described in Article 1.1(a)(1) of the SCM Agreement . Canada
explains that in US – Export Restraints, the panel rejected the proposition that the focus should be on
the effects or results of governmental action, suggesting instead, that the focus should be on the nature
of that action. 25
20. Canada criticizes the "two-part" test used by the Panel to establish whether payments are
"financed by virtue of governmental action". In the view of Canada, the Panel erroneously
concentrated upon the alleged effects of the domestic regulation measures on commercial export
transactions, while commercial export transactions by themselves should have been the real focus for
an analysis under Article 9.1(c) of the Agreement on Agriculture. In particular, Canada submits that
quotas which prevent producers "from selling more milk on the regulated domestic market at a higher
price, than to the extent of the quota allocated to them"
 26 do not constitute "governmental action" that
"finances" payments on the export of dairy products manufactured with CEM. Quotas for the
domestic market have no bearing on a producer's decision to produce or sell CEM, since this decision

23Panel Report, para. 6.38.
24Panel Report, WT/DS194/R and Corr.2, adopted 23 August 2001.
26Panel Report, para. 6.42.

is made before, not after, the production. Moreover, penalties for diversion of milk cannot be
considered as "governmental action" that "finances" payments, since they occur once the transaction
between the producer and processor is completed.
21. Canada stresses further that the Panel failed to take account of its deregulation of the export
market for milk, of the existence of a regulated domestic market and a deregulated export market in
Canada, and of the commercial nature of the transactions for the provision of CEM, namely, that the
transactions are negotiated exclusively by private parties of their own free will. Canada recalls that
the original panel noted that the mere existence of parallel markets with lower export prices did not,
by itself, create an export subsidy, and that the issue was rather the extent of government involvement
in providing the lower-priced product for export. As a result of this approach, the Panel effectively
"collapsed" the domestic support disciplines and the export subsidy disciplines of the Agreement on
Agriculture.
22. Canada challenges the Panel's conclusion that producers are "driven by governmental action
to sell milk produced outside their quota into the export market".
 27 Producers and processors are
under no control or compulsion of the government; they now freely choose to sell or purchase CEM
at prices and terms based on market forces. The Panel's conclusion that producers are "driven" to sell
milk for export is premised on the assumption that producers behave in a "profit-maximizing"
manner. Such an assumption is not a proper basis for identifying WTO-inconsistent subsidies.
Article 9.1(c) does not equate export subsidies with choices between "profit-maximizing" options or
"unfettered commercial freedom". Canada finds it "illogical" that the very act of "deregulating" was
interpreted by the Panel to be governmental "intervention" that restricts producers' commercial
freedom. The mere fact that markets exist within a legal framework established by the government
does not imply that producers' choices are not free in those markets.
23. Canada also emphasizes that the standard developed by the Panel for Article 9.1(c) of the
Agreement on Agriculture is more stringent than the one applicable for an export subsidy under the
SCM Agreement, whereas the subsidy disciplines in the agricultural sector are designed to reduce
agricultural support and protection over time, and are yet to achieve the level of disciplines imposed
by the SCM Agreement.
24. Accordingly, in the view of Canada, there is no "governmental action" which "finances"
payments through the supply of CEM within the meaning of Article 9.1(c) of the Agreement on
Agriculture.

27Panel Report, para. 6.48.

3. Article 10.1 of the Agreement on Agriculture and Article 3.1 of the
SCM Agreement
25. In the event that the Appellate Body deems it necessary to complete the Panel's analysis,
Canada presents the following arguments with respect to Article 10.1 of the Agreement on
Agriculture. In essence, Canada claims that there is no subsidy provided to processors within the
meaning of Article 1(e) of the Agreement on Agriculture and Article 1.1 of the SCM Agreement,
including item (d) of the Illustrative List of Export Subsidies (the "Illustrative List") in Annex I of the
SCM Agreement . Accordingly, Canada's measures are not inconsistent with Article 10.1 of the
Agreement on Agriculture.
26. Canada asserts further that it is not circumve nting its export subsidy commitments within the
meaning of Article 10.1 of the Agreement on Agriculture, since there is no export subsidy involved in
CEM transactions; neither is it circumventing its export subsidy commitments by "non-commercial
transactions" so as to attract application of Article 10.1 of the Agreement on Agriculture.
27. Finally, Canada argues that, as there are no "subsidies" conferred on processors within the
meaning of Article 1.1 of the SCM Agreement, there can be no "export subsidy" within the meaning
of Article 3.1 of the SCM Agreement.
B. Arguments of New Zealand – Appellee
1. Article 9.1(c) of the Agreement on Agriculture – "payments"
28. New Zealand submits that Canada's new measures also are "payments" within the meaning of
Article 9.1(c) of the Agreement on Agriculture. Although prices are determined through negotiations
between producers and processors under the CEM scheme, producers only sell and negotiate prices
for CEM because they are prevented from selling that milk into the domestic market. Canada's
contention that prices are determined by "arm's length private transactions" is based on the erroneous
assumption that these transactions are genuinely voluntary and are purely market-based. Processors
are the beneficiaries of an artificially constructe d market which provides them with milk for export
processing at prices lower than those applicable to the domestic market.
29. New Zealand argues that Canada incorrectly assumes that there are two separate markets. The
domestic and the export markets are, in reality, identical in terms of participants and products, and
they differ only with regard to the degree of go vernment involvement. Should Canada's argument on
"separate markets" be accepted, it would allow Members with domestic supply management schemes
to evade their export subsidy commitments by simply creating a "separate" artificial market through

which processors for export would have access to inputs at subsidized prices. Even if the CEM
market were to be treated as a "separate" market, there would still be "payments" within the meaning
of Article 9.1(c) of the Agreement on Agriculture , because the determinative question is whether
processors for export obtain milk at reduced rates, not whether milk is obtained through one market or
another.
2. Article 9.1(c) of the Agreement on Agriculture – "financed by virtue of
governmental action"
30. New Zealand submits that Canada erroneously restricts the interpretation of Article 9.1(c) of
the Agreement on Agriculture to mean that only "overt" action by government, such as the setting of
prices or the imposition of a levy, would satisfy the requirement that payments are "financed by virtue
of governmental action". New Zealand contends that such an approach is not supported by the
Appellate Body's ruling in Canada – Certain Measures Concerning Periodicals
 28, or by the
negotiating history of the Agreement on Agriculture. Canada improperly isolates the word "financed"
from the other words of the phrase "financed by virtue of ". Furthermore, the phrase "by virtue of "
indicates that Article 9.1(c) cannot be read to mean that it is limited to measures with "levy-type
characteristics". New Zealand contends that Canada overlooks the ordinary meaning of "by virtue of
 "
by substituting its own standard of "a strong affirmative and positive linkage between the government
action and the financing of the payments". New Zealand supports the Panel's view that the degree of
government involvement is not a decisive factor, and that "indispensability" is the appropriate
standard to be applied under Article 9.1(c), in this case, although it is not necessarily the only standard
applicable under this article.
31. New Zealand argues further that the Panel rightly used the "but for" test as it is grounded in
the ordinary meaning of "indispensable". In applying the "but for" test, the Panel did not use "less
than a stringent standard", nor is it founded on mere or incidental governmental involvement.
32. With regard to "governmental action", New Zealand criticizes Canada's argument that its
involvement is not "indispensable" for the financing of payments in this case because it has eliminated
many of the specific factors that were found to be violative in the Appellate Body Report in
Canada – Dairy. Canada's view implies that Article 9.1(c) of the Agreement on Agriculture would
be violated only if the types of action that previously existed under Special Milk Classes 5(d) and 5(e)
were present in the new scheme also. The application of the Appellate Body's ruling in Canada –
Dairy cannot be restricted to such narrowly defined circumstances.

28Appellate Body Report, WT/DS31/AB/R, adopted 30 July 1997, DSR 1997:I, 449.

33. Citing the facts of this case, New Zealand argues that governmental action is clearly
indispensable to the financing of payments made from producers to processors, as concluded by the
Panel by using correctly its "two-part" test.
34. New Zealand expresses its deep reservations on Canada's reference to the SCM Agreement
as contextual support for interpreting Article 9.1(c) of the Agreement on Agriculture . There is
insufficient similarity between the terms of Article 1.1(a)(1) of the SCM Agreement and of
Article 9.1(c) of the Agreement on Agriculture for the SCM Agreement to be of any decisive
guidance. Moreover, Canada, by relying on the panel report in US – Export Restraints , creates an
unwarranted dichotomy between the nature of governmental action and its "effects".
35. New Zealand also believes that Canada is seeking to re-argue the facts of this case by
asserting that producers make free decisions, and that this question falls outside the scope of appellate
review. No rational, profit-maximizing producer would voluntarily forego the opportunity of using
high-priced sales in the domestic market to make a dditional profits, albeit by low-priced sales in the
export market. Canada seeks to reinterpret Article 9.1(c) incorrectly by trying to restrict its
application only to governmental action that, by itself, finances the transfer of resources.
36. Finally, New Zealand disagrees with Canada's view of the Panel's decision as one that
penalizes governments that decide to deregulate.
3. Article 10.1 of the Agreement on Agriculture
37. In the alternative, New Zealand argues that, should the Appellate Body find that Canada's
schemes are not export subsidies within the meaning of Article 9.1(c), the Appellate Body should
conclude that the schemes constitute export subsidies within the meaning of Article 10.1 of the
Agreement on Agriculture.
38. New Zealand argues that the CEM scheme, under which Canada enables processors for
export to obtain milk at prices that are lower than those on the domestic market, constitutes an "export
subsidy" within the meaning of item (d) of the Illustrative List of the SCM Agreement. Accordingly,
it constitutes an "export subsidy" within the meaning of Article 1(e) of the Agreement on
Agriculture, and, hence, within the meaning of Article 10.1 of that Agreement. The CEM scheme
also results in non-commercial transactions bein g used to circumvent Canada's export subsidy
commitments. Finally, New Zealand asserts that CEM transactions are "non-commercial
transactions" that fall within Article 10.1 of the Agreement on Agriculture . Therefore, even if the
Appellate Body were to conclude that the CEM scheme does not constitute an "export subsidy" under

Article 9.1(c), it is in a position to complete the analysis and conclude that the schemes have been
applied in a manner that is contrary to Article 10.1 of the Agreement on Agriculture.
C. Arguments of the United States – Appellee
39. At the outset, the United States emphasizes that Article 10.3 of the Agreement on
Agriculture shifts the burden of proof to Canada to establish that, through its milk management
scheme, including CEM, Canada has not subsidized exports of milk in excess of its export subsidy
commitment levels specified in its Schedule of commitments under the WTO Agreement. According
to the United States, the Panel rightly concluded that Canada has failed to carry its burden.
1. Article 9.1(c) of the Agreement on Agriculture – "payments"
40. The United States rejects Canada's argument that the processors do not receive a "payment"
within the meaning of Article 9.1(c) of the Agreement on Agriculture. The Panel properly concluded
that a "payment" is conferred upon the processors through the provision of discounted milk for export,
whether the price of export milk is compared with the price of domestic milk or with the terms of
imported milk under the Import for Re-export Program ("IREP"), which are the only other sources of
milk available to exporters in Canada.
41. In the view of the United States, the Panel's benchmark analysis is necessary and applicable to
the present case. The Panel did not fail to consider Canada's argument that the deregulated CEM
prices cannot be compared with the regulated prices for milk in the domestic market. In determining
whether there is a "payment" within the meaning of Article 9.1(c) of the Agreement on Agriculture,
the Panel considered Canada's assertion, and found that the degree of government intervention is not
relevant at this stage of the analysis. The United States notes that this approach is consistent with
the Appellate Body Reports in Canada – Measures Affecting the Export of Civilian Aircraft
("Canada – Aircraft
 ") 29 and Canada – Dairy, and that the Panel correctly relied upon the context of
Articles 9.1(b) and 9.1(e) of the Agreement on Agriculture for determining the appropriate
benchmark, and the object and purpose of the Agreement on Agriculture , as support for its
conclusion.
42. The United States agrees with the Panel that the CEM market is not a market in which
transactions occur "privately at arm's length." This market for export milk would cease to exist absent
government intervention. The only difference between Canada's so-called "two" markets is the
degree of government regulation in each. The buyers, the sellers and the product, are all the same.

29WT/DS70/AB/R, adopted 20 August 1999.

Other than price, there is no distinction between milk destined for the export market and milk destined
for the domestic market. Canada has confirmed, during the Panel proceedings, that milk destined for
the export market is not stored or processed separately from other milk.
 30
43. The United States rejects Canada's argument that no benchmark is necessary and that no
benchmark should be used other than the price of CEM itself. The correct approach in analyzing
"payments" under Article 9.1(c) of the Agreement on Agriculture requires a comparison between
what is received by the processor and what is otherwise available to it as an alternative source, and
this comparison remains unaffected by government intervention. Therefore, there is no reason to
disregard domestic price as the appropriate benchmark, particularly because of the fact that the "two"
markets are in reality "one" that has been partitioned by government for differential pricing purposes.
The Appellate Body in Canada – Dairy never suggested to exclude the use of a benchmark and,
more particularly, the use of the domestic market price (or the IREP price). Moreover, the Appellate
Body's interpretation of the term "benefit" in Article 1.1 of the SCM Agreement in Canada –
Aircraft, provides context for the interpretation of "payment" in Article 9.1(c) of the Agreement on
Agriculture and further support for the use of a benchmark.
44. The United States emphasizes that even under the new scheme, exporters still receive milk
that is priced lower than what is otherwise available to them either on the domestic market or through
the IREP. Producers are providing milk for export at a substantial discount to the market price for
milk delivered for domestic consumption. Thus, even under the replacement measures, producers are
foregoing revenue and processors are receiving a be nefit in the same manner that the Appellate Body
in the original proceeding found to constitute a "payment" within the meaning of Article 9.1(c).
45. Finally, the United States submits that Canada cannot dispute that the payment (that is, the
provision of lower-priced milk) is only available in the case of milk purchased for the manufacture of
dairy products destined for the export market. Consequently, the payment constitutes a payment "on
the export of an agricultural product" under Article 9.1(c) of the Agreement on Agriculture.
2. Article 9.1(c) of the Agreement on Agriculture – "financed by virtue of
governmental action"
46. According to the United States, the Panel properly concluded that the payments are "financed
by virtue of governmental action" within the meaning of Article 9.1(c) of the Agreement on
Agriculture.

30Panel Report, footnote 105 to para. 6.16.

47. In particular, the United States is of the view that the Panel rightly referred to the Appellate
Body's analysis in Canada – Dairy in applying what it terms as the "'indispensability' test" in order
to determine whether the payments are "financed by virtue of governmental action." The
United States considers that the "but for" test of the Panel is only an alternative formulation for the
"'indispensability' test", and that this standard, in this case, is grounded in treaty language. Thus, the
Panel did not erroneously equate "by virtue of
 " with "merely influences" or "encourages" as asserted
by Canada, and the Panel only applied the same "'indispensability' test" that the Appellate Body
applied in Canada – Dairy. Canada attempts to restrict unduly the scope of Article 9.1(c) to the
specific levy example. Moreover, the standard proposed by Canada, that is, a "strong affirmative and
positive linkage between the government action and the financing of the payments", seems less
stringent than the one applied by the Panel, which requires governmental action to be "necessary" or
"vital" to the transfer of economic resources in determining whether payments are "financed by virtue
of governmental action".
48. The United States also refers to Canada's argument that the Panel should have considered the
context of the SCM Agreement. The fact that the Panel did not consider the SCM Agreement as
context does not invalidate the Panel's otherwise va lid conclusion regarding the proper standard and
that Agreement, in fact, supports the Panel's conclusion. However, the United States disagrees with
Canada's argument relating to Article 1.1(a)(1)(iv) of the SCM Agreement , based on the panel's
interpretation of that article in its report in US – Export Restraints. The United States is of the view
that the panel's finding in that report is "irrelevant" and that the passages quoted by Canada are "of
decidedly questionable validity given their hypothetical and advisory nature". Furthermore, the
panel's analysis of Article 1.1(a)(1)(iv) in that case only constitutes " obiter dictum a t b e s t a n d
therefore [is] of no legal effect."
 31
49. The United States further argues that the Panel properly applied the "'indispensability' test" to
the facts of the case by articulating its "two-part" test, and by applying the test, examined whether the
governmental actions oblige producers to forego revenue and to sell to the export market. Having
correctly found that these two facts are established in the present case, the Panel concluded that the
governmental action is indispensable to the transfer of resources from the producers to the processors.
The United States supports the Panel's finding that, in the absence of either of the governmental
measures described in its "two-part" test, lower-priced milk could not be provided by the producers to
the processors. Without quotas on the volume of milk that a producer can sell in the higher-priced
domestic market, an "economically rational producer" would not choose to sell in a lower-priced

31United States' appellee's submission, paras. 44 and 45.

export market. Without the governmental requirement that milk contracted for export be exported and
the governmental enforcement of that requirement, export milk would be diverted into the domestic
market thereby undermining the low export price as well as the high domestic price.
50. The United States claims that Canada's response to the "two-part" test in this appeal is to "re-
argue the facts". This falls outside the scope of appellate review. Furthermore, the Panel rightly
found that Canada had not discharged its burden of proof. Therefore, the Appellate Body should
uphold the Panel's conclusion that processors are receiving payments "financed by virtue of
governmental action".
51. The United States disagrees with Canada that the Panel, through its "two-part" test,
improperly focused on the effects of domestic regulation instead of on the measures taken to comply
with the recommendations and rulings of the DSB. The governmental action guarantees that milk in
excess of the quota will be exported and available for exports at a lower price. The "domestic
regulation" referred to by Canada is nothing more than an "artificial segregation" of the milk market
into a "domestic" market and an "export" market. By examining the segregation of the markets, the
Panel analyzed government intervention in the export market, not only in the domestic market, and
considered government action as a whole before concluding that governmental action is indispensable
to the producers providing lower-priced milk to processors. The United States rejects Canada's view
that the Panel failed to take into account the "deregulation" of the export market.
52. Finally, the United States argues that the factual record establishes that processors are
provided milk at discounted prices, contingent on export, only through governmental action.
Therefore, the Panel's conclusion that processors are receiving payments "financed by virtue of
government action" should be upheld.
3. Article 10.1 of the Agreement on Agriculture and Article 3.1 of the
SCM Agreement
53. Should the Appellate Body decide to comple te the legal analysis of the Panel, the
United States submits that, in the alternative, Canada's revised export schemes constitute export
subsidies within the meaning of Article 10.1 of the Agreement on Agriculture . In the view of the
United States, such a finding would be supported by the fact that the revised schemes satisfy each of
the criteria identified in item (d) of the Illustrative List of the SCM Agreement. The United States
further argues that Canada's revised export schemes result in subsidized exports without any
limitation, and threaten to lead to circumvention of Canada's export reduction commitments on milk
products, within the meaning of Article 10.1 of the Agreement on Agriculture . The United States

also emphasizes that, in this case, there is actual circumvention of Canada's export commitment levels
as shown by the fact that Canada's exports of cheese have in fact already exceeded the limitations set
out in Canada's Schedule of Commitments.
54. Finally, should the Appellate Body deem it necessary to complete the analysis of the Panel,
the United States submits that Canada's revised export schemes are prohibited export subsidies under
Article 3.1 of the SCM Agreement as well.
D. Arguments of the European Communities – Third Participant
55. The European Communities supports Canada's contention that the Panel erroneously
broadened the reach of Article 9.1(c) of the Agreement on Agriculture to include a measure which is
not a subsidy within the meaning of that article. The European Communities also agrees with Canada
that Article 9.1(c) can and should be interpreted against the background of the general concept of
"subsidy" as defined under the SCM Agreement. The concept of "subsidy" should not be subject to
diverging interpretations, and it should be interpreted consistently like the concept of "export
contingency". In the view of the European Communities, there are compelling arguments that support
a consistent approach to the interpretation of a subsidy, in particular, the consideration that the
objective of the Agreement on Agriculture is only to limit subsidization of agricultural products, not
to create stricter disciplines on agricultural subsidies than those applicable to industrial products.
1. Article 9.1(c) of the Agreement on Agriculture – "payments"
56. The European Communities considers that the ordinary meaning of the word "payment", read
together with the term "financed", and the levy example contained in Article 9.1(c) of the Agreement
on Agriculture, suggests a transfer of money. In the event that the Appellate Body reaffirms that the
word "payments" includes "payments-in-kind", the European Communities argues that the Panel erred
in finding that the regulated domestic market price constitutes the correct benchmark to determine
whether a "payment" exists. Unlike Articles 9.1(b) and 9.1(e), Article 9.1(c) does not indicate that the
domestic market is the decisive benchmark. The decisive benchmark must be what is otherwise
commercially available to processors on the market, as supported by the immediate context of
Article 9.1(c) as well as Article 14 of the SCM Agreement and item (d) of the Illustrative List of the
SCM Agreement. Since the domestic market in milk is not available to processors for export, the
world market should be used in this case.
57. With regard to the Panel's finding on the requirement that "payments" be "on the export", the
European Communities considers that the Appellate Body should declare this finding to be "moot and

without legal effect" because the Panel erroneously "decoupled" the term "on the export" from the
term "payment" and then equated it with the con cept of export contingency, although the notion of
"payment on the export" involves a more direct and strict link with the export operation.
2. Article 9.1(c) of the Agreement on Agriculture – "financed by virtue of
governmental action"
58. The European Communities considers that the Pa nel erroneously developed the "but for" test
to determine whether the payment is "financed by virtue of governmental action". The Panel's
approach cannot be supported by the term "financed" and the levy example contained in
Article 9.1(c). The European Communities also submits that the Panel's reasoning fails to take
account of the interpretative guidance provided by Article 1.1 of the SCM Agreement, notably, the
phrase "financial contribution".
59. According to the European Communities, the element "financial contribution" in the
SCM Agreement is an "important filter" to "sift" WTO-inconsistent subsidies from any other
governmental measure that may have trade-distortin g effects. The test for determining the element
"financial contribution", as developed by the panel in US – Export Restraints , indicates that
Article 9.1(c) should be limited to cases where governments address a clear command to agricultural
producers to transfer a certain amount of economic resources at a certain price.
60. Finally, the European Communities is of the view that the Appellate Body should not uphold
the Panel's conclusion that "payments" were "financed by virtue of governmental action" because the
Panel incorrectly based its conclusion solely on the two governmental actions set out in its "two-part"
test. Although these actions, if established, may encourage producers to sell CEM, the European
Communities fails to see how the provision of lower-priced milk to processors can be said to be
"imposed" on producers by the government in the circumstances of the present case.
III. Issue Raised in this Appeal
61. The issue raised in this appeal is whether the Panel erred in finding, in paragraph 6.79 of the
Panel Report, that the supply of "commercial export milk" ("CEM") by domestic milk producers to
domestic dairy processors involves "payments" on the export of milk "that are financed by virtue of
governmental action" within the meaning of Article 9.1(c) of the Agreement on Agriculture.

IV. Article 9.1(c) of the Agreement on Agriculture
62. Before the Panel, New Zealand and the United States claimed that the supply of CEM by
Canadian milk producers to Canadian dairy processors, as an input for exports of processed dairy
products, involved export subsidies under Article 9.1(c) of the Agreement on Agriculture. The Panel
addressed this claim by: first, examining whether sales of CEM involve " payments"; second, having
found that they do, whether those payments are " financed by virtue of governmental action ".
 32
(emphasis added); and third, examining whether the payments are made "on the export of an
agricultural product", and concluded that they are. 33 (emphasis added)
63. Canada appeals the Panel's findings on the first and second of these three elements, but does
not appeal the Panel's finding on the third. In our examination of these issues raised by Canada's
appeal, we will follow the same order of analysis , examining, first, the Panel's finding that the
measure involves "payments" and, second, the Panel's finding that those payments are "financed by
virtue of governmental action".
A. "Payments"
64. The Panel recalled our statement in the original proceedings:
… the word "payments" in Article 9.1(c) denotes a transfer of
economic resources, and … the ordinary meaning of the word
"payments" in Article 9.1(c) encompasses "payments" made in forms
other than money, including revenue foregone.
 34 (footnotes omitted)
65. The Panel also referred to the following passage from our Report in Canada – Dairy:
In our view, the provision of milk at discounted prices to processors
for export under Special Classes 5(d) and 5(e) constitutes "payments",
in a form other than money, within the meaning of Article 9.1(c). If
goods or services are supplied to an enterprise, or a group of
enterprises, at reduced rates (that is, at below market-rates),
"payments" are, in effect, made to the recipient of the portion of the
price that is not charged. Instead of receiving a monetary payment
equal to the revenue foregone, the recipient is paid in the form of
goods or services. But, as far as the recipient is concerned, the
economic value of the transfer is precisely the same.
 35

32Panel Report, paras. 6.27 and 6.77.
33Ibid., para. 6.78.
34Ibid., para. 6.12; Appellate Body Report, Canada – Dairy, supra, footnote 2, paras. 107 and 112.

66. The Panel took the view that a determination that CEM is sold by producers at "discounted"
or "reduced" rates, which are "below market", requires a comparison between the prices of CEM and
a "benchmark" that provides a basis for comparison. The Panel found that the "right benchmark", in
this dispute, is the price at which milk is sold by producers in the domestic market.
 36 In reaching
this conclusion, the Panel relied, inter alia , on sub-paragraphs (b) and (e) of Article 9.1 of the
Agreement on Agriculture as context.
67. The Panel also examined a second, alternative benchmark based on world market prices.
Canadian processors wishing to export processed dairy products may import raw milk, or milk
derivatives, under Canada's Import for Re-Export Pr ogramme ("IREP"), provided that the processed
products are exported. The Panel did not examine the parties' arguments regarding the "competitive
relationship" between CEM and dairy products imported under IREP.
 37 Instead, the Panel examined
only the terms and conditions on which dairy products may be imported under IREP. The Panel held
that imports under IREP depend upon the exercise by government of "wide and untrammelled
discretion", as an import permit is required.
 38 In addition, the Panel found that an administrative fee
must be paid to obtain an import permit under IREP. On this basis, and without comparing the prices
of CEM with the prices of dairy products imported under IREP, the Panel concluded that IREP
imports are not "effectively" available on "equally favourable terms" as those offered for commercial
export milk.
 39
68. The Panel concluded that "the provision of milk at discounted prices to processors for export
under the CEM scheme constitutes 'payments', in a form other than money, within the meaning of
Article 9.1(c) of the Agreement on Agriculture." 40
69. On appeal, Canada argues that the Panel failed to take sufficient account of the fact that
supplies of CEM are "no longer subject to government regulation". 41 Canada points out that we
stated in Canada – Dairy that "payments" are made when goods are supplied at "below market-
rates" and for "less than full consideration". 42 Canada emphasizes that the price of CEM is freely

36Panel Report, para. 6.22.
37Ibid., para. 6.26. Imports under IREP, generally, involve whole milk powder, while CEM involves
fluid milk. The Panel noted in this paragraph that the parties had submitted "conflicting evidence" regarding
fluid milk equivalent prices of whole milk powder.
38Panel Report, para. 6.25.
39Ibid.
40Ibid., para. 6.27.
42Appellate Body Report, supra, footnote 2, paras. 87 and 113.

negotiated in the marketplace between the producer and the processor, on a willing-buyer, willing-
seller basis and, accordingly, it represents both market price and full consideration for the milk.
Consequently, Canada contends that no comparison with any benchmark is required.
 43 In Canada's
view, there is, therefore, no "payment" when a producer sells CEM to a processor.
70. Article 9.1(c) of the Agreement on Agriculture reads:
The following export subsidies are subject to reduction commitments
under this Agreement:
…
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;
…
71. We observe, first, that the "payment" which the Panel found to exist in this dispute is effected
through the supply of goods – commercial export milk or CEM. The alleged payment is, thus, not a
monetary payment but a payment-in-kind. As the Panel observed, we held in the original proceedings
that the word "payments" in Article 9.1(c) "encompasses 'payments' made in forms other than money,
including revenue foregone."
 44 It is not contested, in this appeal, that "payments" can include
payments-in-kind in Article 9.1(c) of the Agreement on Agriculture.
72. In the original proceedings, in order to identify whether there were "payments" in
Article 9.1(c), through the supply of milk under Special Milk Classes 5(d) and 5(e), the panel
identified two benchmarks against which to compare the price of milk sold under these Special Milk
Classes. These two benchmarks were (1) domestic prices and (2) the price of milk available to
processors from world markets through imports under IREP. The original panel found that supplies
under Special Milk Classes 5(d) and 5(e) were available on terms and conditions more favourable
than those applicable under both of the two benchmarks on which it relied.
 45 The original panel's

43Canada's appellant's submission, para. 46; see also, para. 36 and footnote 28 thereto.
44Appellate Body Report, Canada – Dairy, supra, footnote 2, para. 112. We note that the Agreement
on Agriculture and the SCM Agreement both use the word "foregone", which can also be spelled "forgone".
45Original Panel Report, Canada – Dairy, supra, footnote 2, para. 7.58. The original panel's analysis of
the benchmarks forms part of its examination of the claims made in those proceedings regarding "payments-in-
kind" under Article 9.1(a) of the Agreement on Agriculture. In examining the claims made regarding
payments-in-kind under Article 9.1(c), the panel relied on its earlier findings under Article 9.1(a). See, original
Panel Report, paras. 7.90 and 7.101.

findings regarding the benchmarks under Articles 9.1(a) and 9.1(c) were not challenged on appeal and
we merely based our examination on the fact that Special Milk Classes 5(d) and 5(e) were supplied to
processors at "discounted" prices or at "below market-rates". In this appeal, Canada's challenge to the
Panel's finding focuses squarely upon the Panel's use of a benchmark as a basis for determining
whether there are "payments" in this dispute.
 46
73. Although we did not have to examine whether the benchmarks used by the panel in the
original proceedings were appropriate, our findings in those proceedings provide guidance in
identifying when "payments" are made under Article 9.1(c). We recall that we upheld the original
panel's finding that "the provision of discounted milk to processors or exporters under Special
Classes 5(d) and 5(e) involves 'payments' within the meaning of Article 9.1(c) of the Agreement on
Agriculture."
 47 (emphasis added) In reaching this conclusion, we noted that, where milk is sold at
"reduced rates (that is, at below market-rates), 'payments' are, in effect, made to the recipient of the
portion of the price that is not charged." 48 (emphasis added) We noted that the producer of the milk
"foregoes" the uncharged portion of the price. 49 In short, we indicated that there are "payments"
under Article 9.1(c) when the price charged by the producer of the milk is less than the milk's proper
value to the producer. 50
74. Thus, the determination of whether "payments" are involved requires a comparison between
the price actually charged by the provider of the goods or services – the prices of CEM in this case –
and some objective standard or benchmark which reflects the proper value of the goods or services to
their provider – the milk producer in this case. We do not accept Canada's argument that as the
producer negotiates freely the price with the processor, and CEM prices are, therefore, market-
determined, it is not necessary to compare these prices with an objective standard.
75. Article 9.1(c) of the Agreement on Agriculture does not expressly identify any standard for
determining when a measure involves "payments" in the form of payments-in-kind. The absence of
an express standard in Article 9.1(c) may be contrasted with several other provisions involving export
subsidies which do provide an express standard. Thus, for instance, even within Article 9.1 itself,

46See, supra, para. 69.
47Appellate Body Report, Canada – Dairy, supra, footnote 2, para. 114.
48Ibid., para. 113.
49Ibid.
50We will examine below the concept of the proper value of goods to the producer, in the context of
these proceedings. See, infra, paras. 86 to 96.

sub-paragraphs (b) and (e) expressly provide that the domestic market constitutes the appropriate
basis for comparison. 51
76. We believe that it is significant that Article 9.1(c) of the Agreement on Agriculture does not
expressly identify a standard or benchmark for determining whether a measure involves "payments".
It is clear that the notion of "payments" encompasses a diverse range of practices involving a transfer
of resources, either monetary or in-kind. Moreover, the "payments" may take place in many different
factual and regulatory settings. Accordingly, we believe that it is necessary to scrutinize carefully the
facts and circumstances of a disputed measure, including the regulatory framework surrounding that
measure, to determine the appropriate basis for comparison in assessing whether the measure involves
"payments" under Article 9.1(c).
77. We turn now to examine the factual and regulato ry setting of the disputed measure in this
appeal. We note that, in these proceedings, certain aspects of the measure at issue are substantially
different from those of the measure at issue in the original proceedings.
78. In the original proceedings, sales of milk under Special Milk Classes 5(d) and 5(e) were
entirely regulated by the Canadian government or its agencies. The government granted permits for
these sales, and also negotiated the sales price with the processors on a transaction-by-transaction
basis. The government also collected the revenues from the sales transactions and allocated them to
producers. The role of the government in regulating the export sales of producers mirrored the role of
the government in regulating sales in the domestic market, where supplies were strictly controlled by
the government through a quota system and where prices were determined by the provincial
marketing boards, which were found by us to be government agencies under the Agreement on
Agriculture.
 52
79. While continuing to regulate the domestic market in the same way, the Canadian government
has now altered its role in regulating export sales by the producers. At present, there are two
categories of export sales of milk by producers. First, under the Special Milk Classes 5(a) to 5(d), the
Canadian government continues to require that export sales be made within a quota and under
government permit. As in the original proceedings, prices for export sales under these Special Milk

51See also, items (c), (d), (f), (g), (h), (j) and (k) of the Illustrative List of the SCM Agreement, each of
which expressly identifies one or more benchmarks to be used as a basis for comparison in determining whether
a measure involves export subsidies. See further, paragraphs 8 and 13 of Annex 3, and paragraph 2 of Annex 4,
of the Agreement on Agriculture, which expressly identify one or more benchmarks for calculating the amount
of domestic support.
52Appellate Body Report, Canada – Dairy, supra, footnote 2, para. 102.

Classes, including in particular Special Milk Class 5(d), are regulated by the government. However,
besides abolishing Special Milk Class 5(e), Canada has now established a second category of export
milk, known as commercial export milk or CEM. Sales of CEM do not require any permit from the
government, and the volume and price of CEM sales are freely negotiated between the producer and
the processor. Each producer decides for itself whether, and when, to produce and sell milk as CEM.
Many producers may find that the production of additional milk for sale as CEM is not profitable and
they are free to decide not to produce such additional milk for export sale. This is borne out by the
fact that many producers do choose not to produce and sell CEM.
 53 Milk sold as CEM cannot be
diverted into the domestic market and dairy products produced with CEM must be exported.
80. With these factual and regulatory circumstances of the new measure in mind, we now
examine the appropriate standard for determining whether the measure at issue involves "payments"
under Article 9.1(c) of the Agreement on Agriculture. In so doing, we begin by reviewing the Panel's
finding that the domestic market provides the "right benchmark" for this dispute.
81. The domestic price in this case is an administered price fixed by the Canadian government as
part of the regulatory framework established by it for managing the supply of milk destined for
consumption in the domestic market. As with administered prices in general, this price expresses a
government policy choice based, not only on econom ic considerations, but also on other social
objectives. The Canadian regulatory framework for managing domestic milk supply, including the
establishment of the administered price, is not in dispute in this case. There can be little doubt,
however, that the administered price is a price that is favourable to the domestic producers.
Consequently, sale of CEM by the producer at less than the administered domestic price does not,
necessarily, imply that the producer has foregone a portion of the proper value of the milk to it. In the
situation where the producer, rather than the gove rnment, chooses to produce and sell CEM in the
marketplace at a price it freely negotiates, we do not believe it is appropriate to use, as a basis for
comparison, a domestic price that is fixed by the government.
82. We, therefore, reverse the Panel's finding, in paragraph 6.22 of the Panel Report, that the
"right benchmark" in these proceedings is the "domestic market price".
54

53Canada asserted before the Panel that about 30 percent of Canadian producers had participated in
CEM transactions since deregulation measures were introduced in August 2000. (Panel Report, para. 4.24)
54See also, our reasoning, infra, in para. 90.

83. The alternative "benchmark" which the Panel relied upon to determine whether CEM prices
involve "payments" was the terms and conditions on which alternative supplies are available to
processors on world markets, through IREP.
 55 In reviewing this benchmark, we recall that, in these
proceedings, the standard used to determine whether there are "payments" under Article 9.1(c) must
be based on the proper value of the milk to the producer, in order to determine whether the producer
foregoes a portion of this value. If a producer wishes to sell milk for export processing, it is obvious
that the price of the milk to the processor must be competitive with world market prices. If it is not,
the processor will not buy the milk, as it will not be able to produce a final product that is competitive
in export markets. Accordingly, the range of world market prices determines the price which the
producer can charge for milk destined for export markets.
 56 World market prices do, therefore,
provide one possible measure of the value of the milk to the producer.
84. However, world market prices do not provide a valid basis for determining whether there are
"payments", under Article 9.1(c) of the Agreement on Agriculture , for, it remains possible that the
reason CEM can be sold at prices competitive with world market prices is precisely because sales of
CEM involve subsidies that make it competitive. Thus, a comparison between CEM prices and world
market prices gives no indication on the crucial question, namely, whether Canadian export
production has been given an advantage. Furthermore, if the basis for comparison were world market
prices, it would be possible for WTO Members to subsidize domestic inputs for export processing,
while taking care to maintain the price of these inputs to the processors at a level which equalled or
marginally exceeded world market prices. There would then be no "payments" under Article 9.1(c)
of the Agreement on Agriculture and WTO Members could easily defeat the export subsidy
commitments that they have undertaken in Article 3 of the Agreement on Agriculture.
 57

55Panel Report, paras. 6.22 ff. See, supra, para. 67. We note that, in examining the terms and
conditions on which IREP is available, the Panel focused exclusively on the requirements to obtain a
discretionary permit and to pay an administrative fee. In assessing whether alternative sources of supply are
available on more favourable terms, we consider that panels should take account of all the factors which affect
the relative "attractiveness" in the marketplace of the di fferent goods or services. The primary consideration
must be price, while the importance of administrative formalities will depend on their nature and characteristics.
For instance, if an import permit were granted to importers as a matter of course, in the context of
straightforward import procedures, and if import fees were only administrative charges to cover expenses, these
formalities would be unlikely, on their own, to mean that imports were available on less favourable terms and
conditions.
56New Zealand acknowledged, before the Panel, that the price of CEM "will be essentially world
market prices". (New Zealand's first submission to the Panel, para. 4.05) Canada also argued that the processor
offers producers a price for CEM that is based on world market conditions. (Canada's first submission to the
Panel, para. 37; Canada's second submission to the Panel, para. 13; Canada's oral statement before the Panel,
paras. 21, 30, 49 and 51; Canada's appellant's submission, para. 39 and footnote 32 thereto)
57We note that none of the participants in these pr oceedings argued that world market prices are the
appropriate benchmark for determining whether supplies of CEM involve "payments" within the meaning of
Article 9.1(c) of the Agreement on Agriculture. See also, supra, footnote 43.

85. We do not, therefore, accept that world market prices are an appropriate basis for determining
whether sales of CEM by producers involve "p ayments" under Article 9.1(c) of the Agreement on
Agriculture.
86. We turn now to determine the appropriate standard for assessing whether sales of CEM by
producers involve "payments" under Article 9.1(c) of the Agreement on Agriculture . We reiterate
that the standard must be objective and based on the value of the milk to the producer.
87. Although the proceeds from sales at domestic or world market prices represent two possible
measures of the value of milk to the producer, we do not see these as the only possible measures of
this value. For any economic operator, the production of goods or services involves an investment of
economic resources. In the case of a milk producer, production requires an investment in fixed assets,
such as land, cattle and milking facilities, and an outlay to meet variable costs, such as labour, animal
feed and health-care, power and administration. These fixed and variable costs are the total amount
which the producer must spend in order to produce the milk and the total amount it must recoup, in
the long-term, to avoid making losses. To the extent that the producer charges prices that do not
recoup the total cost of production, over time, it sustains a loss which must be financed from some
other source, possibly "by virtue of governmental action".
88. In our view, reliance upon the total cost of pr oduction, in this dispute, as a basis for
determining whether there are "payments" within the meaning of Article 9.1(c), is in harmony with
the domestic support and export subsidies disciplines of the Agreement on Agriculture . Under
Article 3 of the Agreement on Agriculture , WTO Members are entitled to provide " domestic
support
 " to agricultural producers within the limits of their domestic support commitments. The
same Article establishes separate disciplines on export subsidies which prohibit WTO Members
from providing such subsidies in excess of their export subsidy commitments.
89. It is possible that the economic effects of WTO-consistent domestic support in favour of
producers may "spill over" to provide certain benefits to export production, especially as many
agricultural products result from a single line of production that does not distinguish whether the
production is destined for consumption in the domestic or export market.
90. We believe that it would erode the distinction between the domestic support and export
subsidies disciplines of the Agreement on Agriculture if WTO-consistent domestic support measures
were automatically characterized as export subsidies because they produced spill-over economic
benefits for export production. Indeed, this is another reason why we do not agree with the Panel that
sales of CEM at any price below the administered domestic price for milk can be regarded as

"payments" under Article 9.1(c) of the Agreement on Agriculture . Such a basis for comparison
would tend to collapse the distinction between these two different disciplines.
91. However, we consider that the distinction between the domestic support and export subsidies
disciplines in the Agreement on Agriculture would also be eroded if a WTO Member were entitled to
use domestic support, without limit, to provide support for exports of agricultural products. Broadly
stated, domestic support provisions of that Agreemen t, coupled with high levels of tariff protection,
allow extensive support to producers, as compared with the limitations imposed through the export
subsidies disciplines. Consequently, if domestic support could be used, without limit, to provide
support for exports, it would undermine the benefits intended to accrue through a WTO Member's
export subsidy commitments.
92. In our view, by relying upon the total cost of pr oduction in this dispute, to determine whether
there are "payments", the integrity of the two disciplines is best respected. The existence of
"payments" is determined by reference to a standard that focuses upon the motivations of the
independent economic operator who is making the alleged "payments" – here the producer – and not
upon any government intervention in the marketplace. More importantly, using this basis for
comparison, the potential for WTO Members to export their agricultural production is preserved,
provided that any export-destined sales by a producer at below the total cost of production are not
financed by virtue of governmental action. The export subsidy disciplines of the Agreement on
Agriculture will also be maintained without erosion.
93. Our approach is supported by the standards used in items (j) and (k) of the Illustrative List of
the SCM Agreement. Item (j) is concerned with export subsidies that arise through the provision by
the government of a variety of export credit guarantee and insurance programmes. Under item (j), the
provision of such services by the government involves export subsidies when the premium rates
charged do not "cover the long-term operating costs and losses of the programmes". (emphasis
added) Thus, the measure of value under item (j) is the overall cost to the government, as the service
provider, of providing the service. Likewise, in item (k), where the government provides export
credits, the measure of the value of the service provided by the government is the amount "which
[governments] actually have to pay for the funds so employed (or would have to pay if they borrowed
on international capital markets…)". Again, the measure of value is by reference to the cost to the
government, as the service provider, of providing the service. Therefore, items (j) and (k) give
contextual support and rationale, for using the cost of production as a standard for determining
whether there are "payments" under Article 9.1(c) of the Agreement on Agriculture in these
proceedings.

94. A producer's cost of production ma y be measured in, at least, two ways. First, for any given
unit of production, for instance a hectolitre of milk, there is an average total cost of production, which
is the total cost of production divided by the total number of units produced, regardless of whether the
production is destined for the domestic or export markets. The total cost of production includes all
fixed and variable costs incurred in the production of all the units in question. Second, there is also
the marginal cost of production which includes only the additional costs incurred by the producer in
producing an extra unit of production. Generally, the marginal cost of production does not include
any amount for the fixed costs of production. Although a producer may very well decide to sell goods
or services if the sales price covers its marginal costs, the producer will make losses on such sales
unless all of the remaining costs associated with ma king these sales, essentially the fixed costs, are
financed through some other source, such as through highly profitable sales of the product in another
market.
95. In the ordinary course of business, an economic operator chooses to invest, produce and sell,
not only to recover the total cost of production, but also in the hope of making profits.
96. Accordingly, in the circumstances of these proceedings, where the alleged payment is made
by an independent economic operator and where the domestic price is administered, we believe that
the average total cost of production represents the appropriate standard for determining whether sales
of CEM involve "payments" under Article 9.1(c) of the Agreement on Agriculture. 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.
97. We observe that, in this part of our findings, we are examining only whether there are
"payments" within the meaning of Article 9.1(c) of the Agreement on Agriculture. Although sales by
a producer below average total cost of production might involve "payments", this does not, by itself,
mean that such sales involve export subsidies . The export subsidy described in Article 9.1(c)
comprises of several elements, the first of which is that there must be "payments". But the
"payments" will be an export subsidy only when they are financed by virtue of governmental action.
Thus, on the basis of the standard of average total cost of production, there will be an export subsidy
only if the below-cost portion of an export sale is "financed by virtue of governmental action".
98. As we have reversed the Panel's findings regarding the standard for determining the existence
of "payments" and have, instead, identified the appropriate standard for these proceedings, namely,
the average total cost of production, we now consider whether we can resolve this aspect of the
dispute by completing the analysis. The Panel found that, in these proceedings, Article 10.3 of the

Agreement on Agriculture reverses the burden of proof so that Canada must establish "that no export
subsidy … has been granted". 58 Although the burden of proof is on Canada, we must nonetheless
complete the analysis solely on the basis of factual findings made by the Panel and uncontested facts
in the Panel record.
99. As regards the cost of production, New Zealand submitted evidence from the Canadian Dairy
Commission (the "CDC") that the cost of production of milk in Canada was C$56.83 per hectolitre.
 59
The United States argued that "less than 30 percent of Canadian farmers cover their cost of production
at an average price of C$57.41/hl and less than 1 percent could cover costs at export market prices of
around C$30/hl." 60 The United States submitted a graph illustrating producers' costs of production. 61
According to this graph, it appears that the lowest cost of production of any producer is around C$30
per hectolitre. However, the data in the graph and the assumptions behind the data are not clear.
100. Canada contested these figures before the Panel. It argued that the figures relied upon by
New Zealand and the United States were too high because they included "imputed returns to labour,
management and equity – costs that are additional charges not generally associated with costing for
production decisions".
 62 Canada submits that a "far more relevant" figure would be based on "direct
input costs (such as costs for feed and supplies) and costs associated with fixed costs (such as interest
payments on debt and depreciation on buildings and equipment)."
 63 In addition, Canada stated that
the cost of production would also include "all ca sh costs of production" but would exclude "imputed
or assigned" amounts that "do not represent actual expenses". 64 Canada submitted its own graph
illustrating the cost of production based on generally accepted accounting principles ("GAAP"). 65
According to this graph, it appears that the lowest cost of production of any producer is around C$19
per hectolitre. However, the data in the graph and the assumptions behind the data are not clear.

58Panel Report, para. 6.6. Canada has not appealed this finding.
59New Zealand's second submission to the Panel, footnote 9 to para. 2.05, and Exhibit NZ-21 submitted
by New Zealand to the Panel. In support of this figure, New Zealand cited a speech given by the Chairman of
the CDC in January 2000 in which he said that a CDC study "estimated the cost of production for milk in
Canada to be C$56.83/hl at that time." New Zealand also provided an exhibit containing the publicly-available
speaking notes of the Chairman for that speech. In these notes, it is said that the CDC determined a "new [cost
of production] of $58.89 per hL".
60United States' second submission to the Panel, para. 13, and Exhibit US-24 submitted by the
United States to the Panel.
61Exhibit US-24 submitted by the United States to the Panel.
62Canada's oral statement before the Panel, para. 19.
63Ibid., para. 20.
64Ibid., footnote 1 to para. 20.
65Exhibit CDA-26 submitted by Canada to the Panel.

101. The Panel record contains data relating to the prices of CEM and domestic market milk.
Canada submitted to the Panel that sales of CEM have been made in the price range of C$19.06 to
C$36.86 per hectolitre, and New Zealand and the United States submitted figures which appear to be
consistent with this range of prices.
 66 New Zealand submitted to the Panel that the price of milk in
the domestic market is between C$49.48 and C$56.06 per hectolitre, while the United States gave an
average figure of C$52.92 per hectolitre. Canada did not contest these figures.
 67 We note, as did the
Panel, that there is a "clear differential" between the prices of CEM and the domestic market price. 68
This suggests the possibility that the prices of CEM might be below the average total cost of
production and, thus, might involve "payments" under Article 9.1(c).
102. However, the Panel did not find it necessary to make any factual findings on the costs of
production and the facts relating to this issue were not the subject of agreement between the parties.
Moreover, the Panel proceedings were conducted without the parties arguing their case, or the Panel
making enquiries, from the perspective of the average total cost of production standard we have
adopted.
103. In these circumstances, we are unable to complete the analysis by determining whether the
supply of CEM involves "payments" under Article 9.1(c) of the Agreement on Agriculture. Yet, we
do not wish to be understood as holding that the supply of CEM does not involve "payments" under
Article 9.1(c). We are simply not in a position to make a ruling on this issue.
104. In conclusion, we have reversed the Panel's finding, in paragraph 6.22 of the Panel Report,
that the "right benchmark" in this dispute is the do mestic market price, and we have also rejected the
Panel's alternative benchmark based on world market prices. Instead, we have adopted as a standard,
for these proceedings, the average total cost of production of the milk producers.
 69 In the light of the
factual record before us, we are unable to determine whether supplies of CEM involve "payments"
under Article 9.1(c) of the Agreement on Agriculture. In these circumstances, we reverse the Panel's
finding, in paragraph 6.27 of the Panel Report, that the provision of CEM "constitutes 'payments', in a
form other than money, within the meaning of Article 9.1(c) of the Agreement on Agriculture." As a
result, we also reverse the Panel's finding, in paragraph 6.79 of the Panel Report, that the measure at

66Panel Report, para. 6.10. At the oral hearing, Canada stated that the weighted-average price for sales
of CEM, for the period of 1 August 2000 to 31 July 2001, in Manitoba, Ontario and Quebec, was C$29 per
hectolitre.
67Panel Report, para. 6.10. At the oral hearing, Canada stated that the price for Class 3 domestic
industrial milk in Canada, for the period of 1 August 2000 to 31 July 2001, was C$58 per hectolitre.
68Panel Report, para. 6.10.
69Supra, para. 96.

issue involves export subsidies under Article 9.1(c) of the Agreement on Agriculture and its finding,
in paragraph 7.1 of the Panel Report, that Canada acted inconsistently with its obligations under
Articles 3.3 and 8 of that Agreement "through the CEM scheme and the continued operation of
Special Milk Class 5(d)". This does not amount to a finding that the measure at issue is WTO-
consistent, but simply that the Panel's findings are vitiated by error of law.
B. "Financed By Virtue of Governmental Action"
105. We turn now to examine Canada's appeal of the Panel's findings on the phrase "financed by
virtue of governmental action". In so doing, we recognize that the Panel's findings were predicated on
the existence of "payments", under Article 9.1(c) of the Agreement on Agriculture , in the form of
supplies of milk at prices below the domestic market prices and that we have found that this is not the
appropriate basis for determining whether there are "payments". We also recognize that the factual
record does not allow us to determine whether there are "payments" under the measure at issue based
on the standard we have adopted of average total cost of production.
106. The Panel took the view that the phrase "financed by virtue of governmental action" implies
"a certain degree of causality".
 70 Recalling our Report, the Panel considered that governmental action
has to be "indispensable" for the payment to take place. 71 The Panel found that it is not required that
a government "force", "direct", or "compel" producers to sell into the commercial export market. 72
107. Having examined the general meaning of the phrase "financed by virtue of governmental
action", the Panel formulated the issue before it in the following way: "would milk processors for
export have access to lower priced commercial export milk in Canada but for governmental
action? " 73 (emphasis in original) The Panel opined that this "but for" standard would be met if the
following two elements were demonstrated:
… that governmental action, de jure or de facto : (i) prevents
Canadian milk producers from selling more milk on the regulated
domestic market, at a higher price, than to the extent of the quota
allocated to them; and (ii) obliges Canadian milk processors to export
all milk contracted as lower priced commercial export milk, and,
accordingly, penalizes the diversion by processors of milk contracted
as commercial export milk to the domestic market.
 74

70Panel Report, para. 6.35.
71Ibid., paras. 6.37, 6.40-6.41 and 6.44.
72Ibid., para. 6.44.
73Ibid., para. 6.41.
74Ibid., para. 6.42.

108. The Panel explained that underlying this analysis was the assumption that milk producers are
"economically rational" and will "try to maximize [their] profits". 75 In the light of this assumption,
the Panel concluded that, if the two elements above were demonstrated, "the choice left to the
Canadian producer is not a real choice."
 76 (emphasis added) In those circumstances, the Panel found
that "the 'reason' [for producers to sell CEM] would be the governmental action driving producers to
the economically second-best option of producing for export." 77 (emphasis added) Moreover,
demonstrating these circumstances "would establish that producers choose the economic second-best
option as a totally rational and predictable reaction to government action taking away the first-best
option [that is, sale in the domestic market at higher prices]."
 78 The Panel also insisted that, to satisfy
its standard, governmental "anti-diversion measures" be in place to "ensure" that export milk is not
diverted back to the domestic market. 79
109. Applying this reasoning, the Panel found, relying on Canadian federal and provincial
governmental action, that the two elements, set forth in the passage cited above from paragraph 6.42
of the Panel Report, were established.
 80 This, the Panel said, meant that CEM "would not be
available to Canadian processors but for the … federal and provincial actions … obliging producers,
at least de facto, to sell outside-quota milk for export". 81 (emphasis in original, underlining added)
Accordingly, the Panel found that "payments" under CEM are "financed by virtue of governmental
action".
 82
110. On appeal, Canada argues that the Panel applied a standard that fails to ensure "a strong
affirmative and positive linkage between governmental action and financing of payments." 83 Canada
contends that the Panel erred by interpreting "fin anced" to mean simply that a payment is "made". 84
Instead, the word "financing" requires that a "government performs functions of raising, furnishing or

75Panel Report, paras. 6.43 and 6.45.
76Ibid., para. 6.45.
77Ibid.
78Ibid.
79Ibid., paras. 6.42 and 6.48.
80Supra, para. 107.
81Panel Report, para. 6.77.
82Ibid., para. 6.79.
83Canada's appellant's submission, paras. 7, 49 and 52.
84Ibid., para. 8.

managing funds". 85 In this case, supplies of CEM do not involve any such funding either by the
government or by a government mandate.
111. We begin with Article 9.1(c) of the Agreement on Agriculture, which covers "payments …
financed by virtue of governmental action , whether or not a charge on the public account is
involved". (emphasis added) We recall that, in the original proceedings, the role of the government in
managing the supply of milk for export was manifest. We stated that:
"[G]overnmental action" is not simply involved; it is, in fact,
indispensable to enable the supply of milk to processors for export,
and hence the transfer of resources, to take place. In the regulatory
framework, "government agencies" stand so completely between the
producers of the milk and the processors or the exporters that we
have no doubt that the transfer of resources takes place "by virtue of
governmental action". 86 (emphasis added)
112. Although the phrase "financed by virtue of governmental action" must be understood as a
whole, it is useful to consider separately the meanin g of the different parts of this phrase. Taking the
words "governmental action" first, we observe 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). In
the original proceedings, we stated that "[t]he essence of 'government' is … that it enjoys the effective
power to 'regulate', 'control' or 'supervise' individuals, or otherwise 'restrain' their conduct, through the
exercise of lawful authority."
 87 In our opinion the word "action" embraces the full-range of these
activities, including governmental action regulating the supply and price of milk in the domestic
market.
113. Mere governmental action is not, however, suff icient for a finding that there is an export
subsidy under Article 9.1(c). 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.
In our view, the link between governmental acti on and the financing of payments will be more
difficult to establish, as an evidentiary matter, when the payment is in the form of a payment-in-kind
rather than in monetary form, and all the more so when the payment-in-kind is made, not by the
government, but by an independent economic operator. In any event, it will not be sufficient simply

85Canada's appellant's submission., paras. 10 and 49.
86Appellate Body Report, Canada – Dairy, supra, footnote 2, para. 120.
87Ibid., para. 97.

to demonstrate that a payment occurs as a consequence of governmental action because the word
"financed", in Article 9.1(c), must also be given meaning.
114. The word "financed" might be given a rather sp ecific meaning such that it would be confined
to the financing of "payments" in monetary form or to the funding of "payments" from government
resources. However, we have already recalled that "payments", under Article 9.1(c), include
payments-in-kind, so the word "financed" needs to cover both the financing of monetary payments
and payments-in-kind.
 88 In addition, Article 9.1(c) explicitly excludes a reading of the word
"financed" whereby payments must be funded from government resources, as the provision states that
payments can be financed by virtue of governmental action "whether or not a charge on the public
account is involved". Thus, under Article 9.1(c), it is not necessary that the economic resources
constituting the "payment" actually be paid by the government or even that they be paid from
government resources. Accordingly, although the words "by virtue of
 " render governmental action
essential, Article 9.1(c) contemplates that payments may be financed by virtue of governmental action
even though significant aspects of the financing might not involve government.
115. It is extremely difficult, however, 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. Governments are constantly engaged in regulation of different kinds in
pursuit of a variety of objectives. For instance, we can envisage that governmental action might
establish a regulatory framework merely enabling a third person freely to make and finance
"payments". In this situation, the link betwee n 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" (emphasis added) 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, even if by a third person,
and governmental action.
 89 In our opinion, the existence of such a demonstrable link must be
identified on a case-by-case basis, taking account of the particular governmental action at issue and its
effects on payments made by a third person.
116. Although the Panel addressed this issue in different ways, we consider that the Panel's
reasoning, taken as a whole, was directed towards establishing the demonstrable link between

88Supra, para. 71.
89Where "payments" do involve a "charge on the public account", the link between the financing of
the payments and governmental action is clearly less difficult to establish.

governmental action and the financing of the payments. 90 We quoted earlier the Panel's statement, in
paragraph 6.42 of its Report, of the two elements which, if demonstrated, would, according to the
Panel, establish that the payments are "financed by virtue of governmental action".
 91 In determining
that these two elements were demonstrated, the Panel concluded that governmental action "obliges" or
"drives" producers to sell CEM. 92
117. It is true that Canadian governmental action establishes a regulatory regime whereby some
milk producers can make additional profits only if they choose to sell CEM. 93 However, even though
Canadian governmental action prevents further domestic sales 94, we do not see how producers are
obliged or driven to produce additional milk for export sale. As we said above, each producer is free
to decide whether or not to produce additional milk for sale as CEM. 95 Furthermore, as we also said,
the majority of Canadian milk producers choose not to sell CEM. 96 For these reasons, we disagree
with the Panel's characterization of the measure as "obliging producers, at least de facto , to sell
outside-quota milk for export". 97
118. In view of our findings on "payments" above, it is not necessary for us to consider further the
Panel's findings on the phrase "financed by virtue of governmental action".

90We observe that the Panel stated: (i) that governmental action need "only establish the conditions
which ensure that the payment … takes place. The governmental action is, in that sense, a necessary condition
for the transfer to take place" (emphasis in original, Panel Report, para. 6.38); (ii) "the Panel considers that for a
payment to be 'financed by virtue of governmental action', it must be established that a payment would not be
financed, i.e. resources would not be transferred from grantor to recipient, but for governmental action"
(emphasis in original, Panel Report, para. 6.39); (iii) there must be "action which is ' indispensable' to the
financing of [the] payment" (emphasis in original, Panel Report, paras. 6.40 and 6.44); and (iv) "[t]he question
which the Panel needs to address is the following: would milk processors for export have access to lower priced
commercial export milk in Canada but for governmental action? Put another way, have the Canadian
government and its agencies taken action which is indispensable for the lower priced milk to be available to
processors for export?" (emphasis in original, Panel Report, para. 6.41)
91See, supra, para. 107.
92See, Panel Report, paras. 6.42, 6.45, 6.48 and 6.77.
93We note that milk sold as CEM could also be sold as animal feed under Milk Class 4(m). The price
of milk sold under Class 4(m) is approximately C$10 per hectolitre and is, therefore, commercially unattractive
when compared with the prices of CEM. See, Panel Report, paras. 4.25 and 6.52.
94According to Canada, the sole purpose of obliging processors to export dairy products manufactured
with commercial export milk and penalizing diversion of this milk into the domestic market, is to protect quota-
holding producers' entitlement to the higher regulated price. (Canada's statement at the oral hearing)
95Supra, para. 79.
96Canada asserted before the Panel that about 30 percent of Canadian producers had participated in
CEM transactions since deregulation measures were introduced in August 2000. (Panel Report, para. 4.24)
97Ibid., para. 6.77.

V. Article 10.1 of the Agreement on Agriculture
119. New Zealand and the United States claim, in the alternative, that, if the measure at issue were
not an export subsidy under Article 9.1(c) of the Agreement on Agriculture, it would be an export
subsidy under Article 10.1 of that Agreement.
120. Article 10.1 of the Agreement on Agriculture reads:
Export subsidies not listed in paragraph 1 of Article 9 shall not be
applied in a manner which results in, or which threatens to lead to,
circumvention of export subsidy commitments; nor shall non-
commercial transactions be used to circumvent such commitments.
(emphasis added)
121. It is clear from the opening clause of Article 10.1 that this provision is residual in character to
Article 9.1 of the Agreement on Agriculture. If a measure is an export subsidy listed in Article 9.1, it
cannot simultaneously be an export subsidy under Article 10.1. In light of the facts available to us,
we have found that we are unable to determine whether the measure at issue is an export subsidy
listed in Article 9.1(c). However, it remains possible that the measure is such an export subsidy.
Clearly, in that event, the opening clause of Article 10.1 means that the measure could not also be an
export subsidy under Article 10.1. In these circumstances, where we are unable to determine the legal
character of the measure under Article 9.1 of the Agreement on Agriculture, we are similarly unable
to rule upon the legal character of the measure under Article 10.1 of that Agreement.
VI. Article 3.1 of the SCM Agreement
122. In these proceedings, the United States also claims that the measure is a prohibited export
subsidy under Article 3.1 of the SCM Agreement. The United States reiterates the arguments it made
to the Panel concerning this claim in its appeal.
 98
123. The relationship between the Agreement on Agriculture and the SCM Agreement is defined,
in part, by Article 3.1 of the SCM Agreement, which states that certain subsidies are "prohibited"
"[e]xcept as provided in the Agreement on Agricultur e". This clause, therefore, indicates that the
WTO-consistency of an export subsidy for agricultural products has to be examined, in the first place,
under the Agreement on Agriculture.

124. This is borne out by Article 13(c)(ii) of the Agreement on Agriculture, which provides that
"export subsidies that conform fully to the [export subsidy] provisions of Part V" of the Agreement
on Agriculture, "as reflected in each Member's Schedule, shall be … exempt from actions based on
Article XVI of GATT 1994 or Articles 3, 5 and 6 of the Subsidies Agreement."
125. In this appeal, we are unable to determine whether the measure at issue "conforms fully" to
Articles 9.1(c) or 10.1 of Part V of the Agreement on Agriculture. In these circumstances, we decline
to examine the claim made by the United States that the measure is inconsistent with Article 3.1 of the
SCM Agreement.
VII. Findings and Conclusions
126. For the reasons set forth in this Report, the Appellate Body reverses the Panel's findings, in
paragraph 6.79 of the Panel Report, that the supply of CEM by domestic milk producers to domestic
dairy processors involves "payments" on the export of milk "that are financed by virtue of
governmental action" under Article 9.1(c) of the Agreement on Agriculture, and, in consequence,
reverses the Panel's finding in paragraph 7.1 of the Panel Report.
127. However, in the light of the factual findings made by the Panel and the uncontested facts in
the Panel record, the Appellate Body is unable to complete the analysis of the claims made by
New Zealand and the United States under Articles 9.1(c) or 10.1 of the Agreement on Agriculture ,
or the claim made by the United States under Article 3.1 of the SCM Agreement.
Signed in the original at Geneva this 12th day of November 2001 by:
Yasuhei Taniguchi
Presiding Member
_________________________ _________________________
Georges Michel Abi-Saab A. V. Ganesan
Member Member