China: WTO Panel Rules Against Chinese Tariff On Imported Auto Parts

Copyright 2009, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on International Trade & Investment–China Focus, January 2009

On July 18, 2008, a World Trade Organization (WTO) dispute settlement panel found that China's tariff on imported auto parts violated WTO law, in particular, the General Agreement on Tariffs and Trade (GATT). The panel also found that the tariff contravened the scheduled tariff commitments China had promised as part of its 2001 WTO accession agreement to increase access to its automobile market and not to treat parts as whole cars.

Central to the dispute was a 2005 Chinese regulation that imposed a 60% local content requirement on all domestically produced automobiles. Part of China's WTO accession package set a maximum tariff of 25% on imported whole vehicles and a maximum tariff of 10% on imported auto parts. However, the 2005 Chinese regulation imposed a 25% tariff on auto parts if the parts constituted 40% or more of any domestically assembled vehicle.

Canada's former minister of trade, David Emerson, said that the high tariff made it "uneconomic" for Canadian parts suppliers to export to China, and it cost Canadian auto companies hundreds of millions of dollars in lost revenues. In addition, because of the relative increase in the cost of exporting to China, the tariff put pressure on foreign companies to shift production to China. In effect, the tariff operated as a subsidy to Chinese producers and a tax on foreign producers.

Perturbed by the Chinese regulation, the European Communities, the United States and Canada (as co-complainants) challenged its validity in 2006 by requesting the establishment of a WTO dispute settlement panel. During the hearings, the WTO panel also considered third-party submissions from Argentina, Japan, Mexico, Australia and Brazil, most of whom alleged that China was in violation of WTO law.

Pursuant to a request by the United States, the panel issued three separate sets of conclusions, one for each of the co-complainants. With respect to imported auto parts in general, there were common threads within each set of conclusions and recommendations. In each case, the panel found that the Chinese tariff violated GATT Article III:2, III:4 and XX(d).

Defined broadly, Article III of the GATT – national treatment on internal taxation & regulation – states that Members may not use internal measures to discriminate between domestic goods and those imported from Members, that is to say that imports are accorded "national treatment". Article XX lists a series of general exceptions that grants Members permission to apply non-arbitrary and non-discriminatory measures against certain imports for particular reasons including, under paragraph (d), those necessary to secure compliance with laws that are not inconsistent with the GATT.

The co-complainants argued that China's 25% tariff on imported auto parts violated Article III:2 of the GATT, which reads as follows: "[t]he products of the territory of any Member [i.e., country] imported into the territory of any other Member shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied directly or indirectly, to like domestic products." In agreeing with the co-complainants, the panel reasoned that the tariff subjected imported auto parts to an internal charge in excess of that applied to like domestic auto parts.

The co-complainants also argued successfully that the tariff violated Article III:4 of the GATT. The relevant part of Article III:4 states that "[t]he products of the territory of any Member party imported into the territory of any other Member shall be accorded treatment no less favourable than that accorded to like products of national origin in respect of all laws, regulations and requirements affecting their internal sale, offering for sale, purchase, transportation, distribution or use...." The three elements of Article III:4 are: 1) the imported and domestic products are "like products"; 2) the measure at issue is a "law, regulation, or requirement affecting their internal sale"; and 3) the imported products are accorded "less favourable" treatment than that accorded to like domestic products.

With respect to meeting the first element of the Article III:4 test, the panel found that the only difference between the auto parts used to manufacture vehicles in China was origin. The panel reasoned that the mere fact that a good had Chinese origin did not render it "unlike" an imported good. With regard to the second element, the panel concluded that the measures were "laws or regulations" in that they were mandatory for all vehicle manufacturers using imported parts. On the final element, the panel found that since the tax on imported auto parts was "in excess" of that on domestically produced auto parts, the imported parts were treated less favourably.

Article XX(d) of the GATT has two elements that must be shown in order for a measure to be justified under the paragraph. First, the measure must be designed to "secure compliance" with laws or regulations that are not themselves inconsistent with some provision of the GATT; and second, the measure must be "necessary" to secure such compliance. In its submissions, China argued that the auto parts regulations secured compliance with China's tariff scheduled reductions negotiated as part of its WTO accession commitments in 2001 in that the measures prevent foreign exporters, who were previously taking advantage of lower tariff rates for auto parts, from shipping motor vehicles to China in several large pieces. In rejecting this argument, the WTO panel found that China had not adequately explained how what China claimed amounted to "circumvention" of the tariff provisions for motor vehicles was inconsistent with the obligations under its tariff schedule and hence needed to be prevented by a 25% tariff.

In spite of its first loss at a WTO panel ruling, China remains resolute that its local content measures are a legitimate manner to deter foreign automakers from shipping vehicles to China in large pieces as a way to avoid the 25% tariff on whole cars. Accordingly, China filed a notice of appeal to the WTO dispute settlement appellate body on September 15, 2008 and a final decision on this matter remains outstanding.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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