NOVEMBER 04, 2019

By S Murugappan, Advocate, Chennai

THE World Trade Organisation's (WTO) dispute settlement panel gave a jolt to the Indian exporting community when it circulated its report on 31 October 2019 against a dispute raised by United States in 2018 on the various export incentive schemes provided by India.

The panel has held that the export oriented units (EOU) scheme, export promotion capital goods (EPCG) scheme, the special economic zones (SEZ) scheme and the merchandise exports from India (MEIS) scheme violate the WTO agreement on Subsidies and Countervailing Measures (SCM). As a result the panel has recommended that India withdraw all these prohibited subsidies within specific periods.

It is reported that India proposes to appeal to the appellate body against these findings.

It all started with the United States seeking consultations with India in March 2018 against export subsidies provided by it under these schemes on the ground that they hurt United States interests and fair trade and are inconsistent with the SCM Agreement. Not satisfied with the consultations, it requested for constitution of a panel by the Dispute Settlement Body in May 2018 and the panel was established thereafter. Canada, China, European Union as well as several other countries joined as third-parties. After conclusion of the hearings the panel has circulated its report on 31st October 2019 for adoption by members.

Apart from the four schemes mentioned above, the United States challenged the duty-free imports for exports under Notification 50/2017 (Customs) dated 30.6.2017 (Referred to as DFIS by the panel in its report) also as constituting a subsidy. The panel has partly ruled in favour of United States with regard to the challenge to this scheme. But in respect of the remaining four important schemes on which India as well as Indian exporters depend on for boosting the exports, India has lost the case.

The case of the United States against India in respect of the above schemes is that they constitute subsidies which are contingent upon export performance and hence prohibited in terms of Article 3.1 of the agreement on Subsidies and Countervailing Measures. This article reads as follows

"3.1 Except as provided in the Agreement on Agriculture, the following subsidies, within the meaning of Article 1, shall be prohibited:

(a) subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I;

(b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods."

Article 1.1 of the above agreement defines what is a subsidy. It reads as follows.

" 1.1 For the purpose of this Agreement, a subsidy shall be deemed to exist if:

(a)(1) there is a financial contribution by a government or any public body within the territory of a Member (referred to in this Agreement as "government"), i.e. where:

(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion), potential direct transfers of funds or liabilities (e.g. loan guarantees);

(ii) government revenue that is otherwise due is foregone or not collected (e.g. fiscal incentives such as tax credits);

(iii) a government provides goods or services other than general infrastructure, or purchases goods;

(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carry out one or more of the type of functions illustrated in (i) to (iii) above which would normally be vested in the government and the practice, in no real sense, differs from practices normally followed by governments;

or

(a)(2) there is any form of income or price support in the sense of Article XVI of GATT 1994;

and

(b) a benefit is thereby conferred."

Arguments advanced by India.

The preliminary argument adopted by India is that Article 3.1 referred to above will not apply to it until 2025. It was argued that India is covered by Annex VII as a ‘developing country member' as referred to in paragraph (b) of Article 27.2. This Article is worded as follows.

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

(a) developing country Members referred to in Annex VII.

(b) other developing country Members for a period of eight years from the date of entry into force of the WTO Agreement, subject to compliance with the provisions in paragraph 4."

"The developing country Members not subject to the provisions of paragraph 1(a) of Article 3 under the terms of paragraph 2(a) of Article 27 are:

(a) Least-developed countries designated as such by the United Nations which are Members of the WTO.

(b) Each of the following developing countries which are Members of the WTO shall be subject to the provisions which are applicable to other developing country Members according to paragraph 2(b) of Article 27 when GNP per capita has reached USD 1,000 per annum: Bolivia, Cameroon, Congo, Côte d'Ivoire, Dominican Republic, Egypt, Ghana, Guatemala, Guyana, India, Indonesia, Kenya, Morocco, Nicaragua, Nigeria, Pakistan, Philippines, Senegal, Sri Lanka and Zimbabwe."

It was India's case that its GNP per capita reached USD 1000 per annum for a period of three consecutive years only by 2016 and therefore it will not come within the purview of article 3(1) for eight years only from 2017. The WTO agreement entered into force with effect from 1 st January 1995 and the eight year period ended for all members by 1st January 2003. The panel concluded that ‘the annex VII does not provide any basis for departing from the text of article 27.2 (b') and held that the eight year transition period runs from 1 st January 1995 for all countries. Thus the preliminary ground raised by India was rejected and the stand of the panel in this regard appears unassailable.

Case of the United States.

United States has argued that the benefits given under these schemes go beyond the offsetting of the duty incidence on inputs incorporated in the products exported. The SCM agreement permits exemption from customs duties on inputs that are consumed in the production of the exported product. It was argued that the EOU scheme, EPCG scheme and the SEZ scheme provide incentives not only for inputs but go beyond that and provide subsidies on capital goods as well as other items. India argued that the capital goods contribute to the final cost of the exported product and, therefore, they should be extended the same treatment of ‘inputs'. However it was held by the panel that contributing to a product's cost is not the same as being consumed in the production of the product and, accordingly, the contention made by India in this regard was rejected. It was also observed by the panel that as per the foreign trade policy provisions adopted by India, incentives are extended for importation of goods for creating a central facility for establishing export-oriented units, SEZ units etc and that these go well beyond the duty exemption permitted for inputs that get consumed and form part of the export product.

This scheme provides incentives to exporters as a fixed percentage of the value of the exports made. The scrips issued under this scheme can be freely transferred for its money value and can be used as cash equivalent for payment of duties and taxes. The United States has argued that such scrips by even any remote possibility, do not constitute reimbursement of taxes and duties suffered on the inputs used in the production of the export product. India's argument was that the value of the tax suffered represents a fixed percentage of the value of the exports and that the rates are set at a level that approximates but is less than the taxes to be refunded. It was also argued that ‘relying on uniform but lower rate allows it to avoid the administratively cumbersome task of calculating the precise refund for every product and every export'. According to the United States there is no evidence to establish that the scrips have any link to refund of indirect taxes already paid and that India's argument in this regard is nothing but a ‘fiction'.

By referring to the objectives set out in the Foreign Trade Policy and also the fact that different reward rates are prescribed depending upon different destinations/markets for the same product, the panel has observed that it is difficult to hold that these percentages can be treated as refunding of previously accrued indirect taxes.

The foreign trade policy 2015 – 2020 mid-term review provided for increasing the rate of reward for readymade garments and made ups from 2% to 4% and it also granted across-the-board increase of 2% in existing MEIS incentives for exports by MSME units as well as labour-intensive industries. The panel pointed out that nothing in this review shows that the increase in the rewards in this manner is linked to the level of indirect taxes paid on the inputs consumed in the production of exported products and that in the absence of any such link it is difficult to hold that the MEIS scrips are intended to remit or refund the indirect taxes suffered on the inputs. The panel also referred to the Foreign Trade Policy provisions which stated that the objective of the scheme is to provide rewards to exporters to ‘offset infrastructural inefficiencies and associated costs' and that the scheme is to ‘promote the manufacture and export of notified goods'. Hence it concluded that there is no nexus between the percentage of reward under MEIS scheme and the quantum of indirect taxes suffered on the inputs used in the production of the export product.

Infringement of other stipulations

The definition of subsidy as contained in Article 1 includes 1) government practice involving a direct transfer of funds, 2) government revenue that is otherwise due is foregone and 3) a benefit is thereby conferred on the exporter. The panel found that in respect of MEIS scrips there is a direct transfer of funds to the beneficiary as by using these scrips the holder can pay customs duties and other taxes and also sell the scrips for money. It was also observed by the panel that under the EOU, EPCG and SEZ schemes the government of India is foregoing revenue and duties which are otherwise due to it.

The United States also challenged the schemes on the ground that these are export contingent within the meaning of Article 3.1 (a) and thus by providing these subsidies India is acting inconsistently with the provisions of SCM agreement. As formulated, the benefits under these schemes are subject to export performance and stipulated export obligations. In this background the panel straightaway found that the benefits under these schemes are contingent upon export performance and held that such incentives are, therefore, prohibited under the agreement.

With regard to the challenge to duty free imports of certain goods for use in manufacture of export goods in terms of Notification 50/2017 (Cus.), the panel found that the arguments of United States cannot be sustained in respect of a few entries in the notification. However it upheld the objections of United States at least in respect of 5 entries.

On the basis of these findings the panel has recommended that India withdraw the prohibited subsidies under the EOU/EHTP/BTP scheme, EPCG scheme and MEIS scheme within 120 days from adoption of the report the exemption benefits under DFIS within 90 days from adoption and the subsidies under SEZ scheme within 180 days of adoption of the report.

The future :

It is a known fact that in the competitive international markets, Indian exporters keep low margins for survival and for many of them these export incentives are the only benefits that keep them going. As a matter of fact, the foreign buyers reportedly negotiate for lower prices with the Indian exporters citing such incentives and by claiming to share a portion of such benefits. In this background how the Indian exporting community will respond, if these incentives are withdrawn remains to be seen. It is reported that, annually around USUSD 7 billion are involved in such incentives.

It appears that the government of India is toying with the idea of bringing in a ‘remission of duties or taxes on export product scheme'. However if the scheme is only limited to the remission of duties and taxes suffered on the inputs used in the export product and is fully compliant with the SCM agreement, then the major chunk of benefits available to exporters for procuring capital goods and other items free of import duties or for procuring machinery and capital equipment for setting up central facilities and special economic zones will not be available and it will put pressure on them to look at other avenues to remain competitive.

Surely, India would be filing appeal to the appellate body against the report of the panel. But how it will deal with the precise objections made by the United States and also the specific findings rendered by the panel and how the Indian exporters will reconcile to a world without the EOU, EPCG, SEZ and MEIS schemes will be big question marks.

[The views expressed are strictly personal.]