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China Measures affecting imports of automobile parts WT/DS 339 First written submission by the European Communities Geneva 13 March 2007

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Page 1: China Measures affecting imports of automobile parts WT/DS 339 …trade.ec.europa.eu/doclib/docs/2007/july/tradoc_135187.pdf · 2019. 4. 29. · China – Measures affecting imports

China − Measures affecting imports of automobile parts WT/DS 339

First written submission by the European Communities

Geneva 13 March 2007

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China – Measures affecting imports of automobile parts First Written Submission WT/DS 339 by the European Communities ______________________________________________________________________

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TABLE OF CONTENTS

I. INTRODUCTION.................................................................................................. 1

II. BACKGROUND .......................................................................................................... 3

A. Overview of Chinese Automotive Market ..................................................... 4

1. Vehicle production and sales............................................................ 4 2. Auto parts production and sales ....................................................... 6

B. Summary of Chinese Measures Favouring Domestic Content in the Automotive Industry prior to WTO Accession.............................................. 7

C. China’s Commitments in Relation to Auto Parts and Vehicles upon Accession to the WTO................................................................................... 8

D. Introduction of New Measures ..................................................................... 9

1. The Measures ................................................................................... 9 2. Automotive Policy Order ............................................................... 10 3. Decree 125 and Announcement 4................................................... 11

E. Substantive Criteria for Determining the Imposition of Internal Charges at the “Whole Vehicle” Rate .......................................................................... 12

1. Determining whether Imported Parts are Deemed Whole Vehicles........................................................................................................ 12

2. Determining whether Assemblies are Deemed Imported............... 14

F. Additional Administrative Burden Imposed on Vehicle and Auto Parts Manufacturers under the Measures ........................................................... 15

1. Registration of vehicle models ....................................................... 16 2. Customs clearance and bonding requirements ............................... 17 3. Verification procedures .................................................................. 18 4. Payment of charges......................................................................... 19 5. Additional procedural requirements in case of changes to the

vehicle model or options fitted on the vehicle model .................... 20 6. Burden on auto parts manufacturers............................................... 20

G. Example of Application of the Measures.................................................... 21

H. Impact of the Measures .............................................................................. 26

III. LEGAL ARGUMENT ......................................................................................... 28

A. Preliminary considerations ........................................................................ 28

B. The Measures are inconsistent with the agreement on Trade Related Investment Measures ("TRIMs") and the terms and conditions of China's accession to the WTO on TRIMs ................................................................ 29

1. Introduction .................................................................................... 29

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2. The Measures are inconsistent with Article 2 of the TRIMs Agreement in conjunction with paragraph 1 (a) of the Illustrative List annexed thereto ....................................................................... 30 (a) Introduction ........................................................................ 30 (b) The Measures are "investment measures".......................... 31 (c) The Measures are "trade-related" ....................................... 33 (d) The Illustrative List ............................................................ 34

i) Local content requirements ................................................................34 ii) "Compliance with which is necessary to obtain an advantage" ..........36

♦ Lower charges as an advantage ...........................................37 ♦ Procedural advantages.........................................................38

(e) Conclusion.......................................................................... 40 3. The Measures are inconsistent with Article 2 of the TRIMs

Agreement in conjunction with paragraph 2 (a) of the Illustrative List annexed thereto ....................................................................... 40 (a) Introduction ........................................................................ 40 (b) The Measures fall squarely within the description in

paragraph 2 (a) of the Illustrative List................................ 40 4. The Measures are inconsistent with China's obligations under the

WTO Agreement, as set out in the Protocol of Accession of the People's Republic of China to the WTO ........................................ 42 (a) The terms of China's accession to the WTO ...................... 42 (b) The Measures are inconsistent with the Accession Protocol

............................................................................................ 43

C. The Measures are inconsistent with Article III of GATT 1994 .................. 44

1. Introduction .................................................................................... 44 2. The Measures are inconsistent with Article III:4 GATT 1994 ...... 45

(a) Introduction ........................................................................ 45 (b) The products are "like"....................................................... 46 (c) The measures at issue are laws, regulations, or requirements

affecting the internal sale, offering for sale, purchase, transportation, distribution, or use of the imported products............................................................................................ 46

(d) Treatment no less favourable ............................................. 48 3. The Measures are inconsistent with Article III:2 of the GATT 1994

........................................................................................................ 50 (a) Article III:2, first sentence of the GATT 1994.................... 50

i) The products are "like" .......................................................................51 ii) The internal charges applied to imported products are "in excess of"

those applied to like domestic products..............................................52 iii) Conclusion..........................................................................................52

(b) Article III:2, second sentence of the GATT 1994 ............... 52 i) The imported and the domestic products are "directly competitive or

substitutable" ......................................................................................53 ii) The directly competitive or substitutable imported and domestic

products are "not similarly taxed" ......................................................54 iii) The dissimilar taxation of the directly competitive or substitutable

imported domestic products is "applied ... so as to afford protection to domestic production"..........................................................................55

iv) Conclusion..........................................................................................55 4. The Measures are inconsistent with Article III:5 of the GATT 1994

........................................................................................................ 56

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(a) Article III:5, first sentence of GATT 1994 ......................... 56 i) The Measures are an "internal … regulation".....................................57 ii) The Measures are "quantitative … relating to the mixture, processing

or use of products in specified amounts or proportions" ....................57 iii) The Measures "requir[e], directly or indirectly, that any specified

amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources"..........................58

iv) Conclusion..........................................................................................59 (b) Article III:5, second sentence of GATT 1994..................... 60

5. The Measures are inconsistent with the WTO Agreement, as set out in the Protocol of Accession of the People's Republic of China to the WTO, in particular Part I, paragraph 7.2 of the protocol of Accession of China......................................................................... 60

D. Alternatively: The Measures are inconsistent with Article II:1 (a) and (b) of the GATT 1994 ........................................................................................... 61

1. Introduction .................................................................................... 61 2. Description of the Chinese tariff schedule and the relevant bound

rates of duty .................................................................................... 63 (a) General considerations ....................................................... 63 (b) Complete vehicles .............................................................. 64 (c) Intermediate products ......................................................... 66 (d) Parts .................................................................................... 67 (e) Conclusion.......................................................................... 68

3. The inconsistency of the Measures with Chinese tariff commitments and Article II GATT 1994............................................................... 68 (a) Preliminary considerations ................................................. 68 (b) The ordinary meaning of the Chinese tariff schedule ........ 69 (c) Contextual analysis............................................................. 71

i) Article 21(2)(b) and (c) of Decree 125 ...............................................72 ii) Article 21(2)(a) of Decree 125 ...........................................................74 iii) Article 21(1) of Decree 125................................................................75 iv) Article 21(3) of Decree 125................................................................78

(d) Object and purpose............................................................. 78 (e) Conclusion.......................................................................... 79

E. The Measures are inconsistent with Article 3 of the Agreement on Subsidies and Countervailing Measures .................................................................... 79

1. Introduction .................................................................................... 79 2. The Measures constitute a subsidy within the meaning of Article 1

of the SCM Agreement................................................................... 80 (a) Financial contribution......................................................... 81 (b) Benefit ................................................................................ 82

3. The subsidy is contingent upon the use of domestic over imported goods .............................................................................................. 82

4. Conclusion...................................................................................... 84

IV. CONCLUSION.......................................................................................................... 84

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TABLE OF CASES REFERRED TO IN THIS SUBMISSION

WTO DISPUTE SETTLEMENT REPORTS AND ARBITRATION AWARDS

Short Title Full Case Title and Citation

Canada – Aircraft Appellate Body Report, Canada – Measures Affecting the Export of Civilian Aircraft, WT/DS70/AB/R, adopted 20 August 1999, DSR 1999:III, 1377

Canada – Autos Appellate Body Report, Canada – Certain Measures Affecting the Automotive Industry, WT/DS139/AB/R, WT/DS142/AB/R, adopted 19 June 2000, DSR 2000:VI, 2985

Canada – Periodicals Appellate Body Report, Canada – Certain Measures Concerning Periodicals, WT/DS31/AB/R, adopted 30 July 1997, DSR 1997:I, 449

EC – Asbestos Appellate Body Report, European Communities – Measures Affecting Asbestos and Asbestos-Containing Products, WT/DS135/AB/R, adopted 5 April 2001, DSR 2001:VII, 3243

EC – Bananas III Appellate Body Report, European Communities – Regime for the Importation, Sale and Distribution of Bananas, WT/DS27/AB/R, adopted 25 September 1997, DSR 1997:II, 591

EC – Chicken Cuts Appellate Body Report, European Communities – Customs Classification of Frozen Boneless Chicken Cuts, WT/DS269/AB/R, WT/DS286/AB/R, and Corr.1, adopted 27 September 2005

India – Autos Panel Report, India – Measures Affecting the Automotive Sector, WT/DS146/R, WT/DS175/R and Corr.1, adopted 5 April 2002, DSR 2002:V, 1827

Indonesia – Autos Panel Report, Indonesia – Certain Measures Affecting the Automobile Industry, WT/DS54/R, WT/DS55/R, WT/DS59/R, WT/DS64/R and Corr.1, 2, 3, and 4, adopted 23 July 1998, DSR 1998:VI, 2201

Japan – Alcoholic Beverages II Appellate Body Report, Japan – Taxes on Alcoholic Beverages, WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R, adopted 1 November 1996, DSR 1996:I, 97

Korea – Various Measures on Beef

Appellate Body Report, Korea – Measures Affecting Imports of Fresh, Chilled and Frozen Beef, WT/DS161/AB/R, WT/DS169/AB/R, adopted 10 January 2001, DSR 2001:I, 5

US – FSC Appellate Body Report, United States – Tax Treatment for "Foreign Sales Corporations", WT/DS108/AB/R, adopted 20 March 2000, DSR 2000:III, 1619

GATT DISPUTE SETTLEMENT

Short Title Full Case Title and Citation

EEC – Parts and Components GATT Panel Report, European Economic Community – Regulation on Imports of Parts and Components, L/6657, adopted 16 May 1990, BISD 37S/132

Italy – Agricultural Machinery

GATT Panel Report, Italian Discrimination Against Imported Agricultural Machinery, L/833, adopted 23 October 1958, BISD 7S/60

US – Section 337 Tariff Act GATT Panel Report, United States Section 337 of the Tariff Act of 1930, L/6439, adopted 7 November 1989, BISD 36S/345

US – Tobacco GATT Panel Report, United States Measures Affecting the Importation, Internal Sale and Use of Tobacco, DS44/R, adopted 4 October 1994, BISD 41S/131

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TABLE OF ABBREVIATIONS USED IN THIS SUBMISSION

Abbreviation Definition Accession Protocol WTO, Accession of the People’s Republic of China, Decision of 10 November

2001, WT/L/432, November 23, 2001 Accession Schedule Schedule CLII to the Accession of the People’s Republic of China, WT/L/432,

November 23, 2001 Announcement 4 Public Announcement No. 4, “Regarding Regulations on the Ratification of

Imported Automotive Parts and Components Fulfilling the Characteristics of a Whole Vehicle”, issued March 28, 2005 by China’s General Administration of Customs in accordance with Decree 125.

Auto News 2005 Automotive News/Automotive News Europe (Supplement), Guide to China’s Auto Market, May 2, 2005

Auto News 2006 Automotive News/Automotive News Europe (Supplement), 2006 Guide to China’s Auto Market, May 1, 2006

Automotive Policy Order 1994

Formal Policy on Development of Automotive Industry, February 19, 1994

Automotive Policy Order Policy on Development of the Automotive Industry, Order of the National Development and Reform Commission (No.8), May 21, 2004

Bonded Warehouses Order Order No. 105 of the Customs, “Provisions of the Customs of the People’s Republic of China on the Administration of Bonded Warehouses and the Goods Stored Therein”, dated December 5, 2003 and effective February 1, 2004.

Bonding Procedures Procedures on Customs Control over Bonded Areas, promulgated by Customs on August 1, 1997, and effective on that date

CKD Completely Knocked-Down kit (of auto parts to be assembled into a whole vehicle)

Customs General Administration of Customs of the People’s Republic of China Customs Joint Bulletin 38 Customs General Administration Joint Bulletin No. 38, July 5, 2006 Decree 125 Decree No. 125, “Administrative Measures for the Import of Automobile

Components Fulfilling the Characteristics of a Whole Vehicle”, issued February 28, 2005 jointly by China’s General Administration of Customs, NDRC, Ministry of Finance and Ministry of Commerce in accordance with the Automotive Policy Order, effective April 1, 2005

E&Y Report Ernst and Young Report, “China’s Automotive Section – at the crossroads” (undated)

GATT General Agreement on Tariffs and Trade Global Insight Report Global Insight Report: China (Automotive), January 31, 2007 Harmonized System Harmonized Commodity Description and Coding System KPMG Asia Report KPMG Report, Automotive and Components Market in Asia – Advisory, March

2005 KPMG China Report KPMG Report, “China Automotive and Components Market 2005 – Industrial

Markets”, November 2005 NDRC National Development and Reform Commission of the People’s Republic of

China SCM Agreement Agreement on Subsidies and Countervailing Measures SKD Semi-Knocked Down kit (of auto parts to be assembled into a whole vehicle) TRIMs Agreement Agreement on Trade-Related Investment Measures Warehouse Order Provisions of the Customs of the People’s Republic of China on the

Administration of Bonded Warehouses and the Goods Stored Therein, issued as Order No. 105 by Customs on December 5, 2003 and coming into force on February 1, 2004

Working Party Report Report of the Working Party on the Accession of China, WT/ACC/CHN/49, October 1, 2001

Working Party Report – Border Tax Adjustments

WTO, Report of the Working Party on Border Tax Adjustments, L/3464 – BISD 18S/97, adopted December 2, 1970

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Abbreviation Definition WTO Agreement Marrakesh Agreement Establishing the World Trade Organization

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China – Measures affecting imports of automobile parts First Written Submission WT/DS 339 by the European Communities ______________________________________________________________________

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I. INTRODUCTION

1. China, as a WTO Member, has undertaken to comply with the obligations set out

in the Marrakesh Agreement Establishing the World Trade Organization (WTO

Agreement). It has undertaken to open its markets, in part through the reduction of

tariffs on auto parts1 and by eliminating its domestic-content requirements. Despite

commitments made during WTO accession2, China has re-erected old barriers in

the form of various measures (“Measures”).3 These Measures inhibit the import of

auto parts by making them “equivalent” to imported vehicles, a completely distinct

category of products. China once again treats domestic and imported auto parts as

different, applying internal charges to imported auto parts without any equivalent

charges applied to "like" domestic parts. Through the Measures, China:

i) imposes different internal charges on vehicles manufactured in China depending on their domestic content;

ii) imposes those internal charges on imported auto parts, but not on domestic auto parts; and

iii) imposes additional administrative requirements with respect to imported auto parts that are not imposed on domestic auto parts.

2. There can be no illusion about the objective of these Measures. They are intended

to make imported auto parts – parts that are in every way like domestic auto parts

– more expensive and consequently less competitive than the domestic equivalent,

and to encourage investment in local part manufacture.

3. The Measures impose internally what China cannot do externally. They render it

more costly to import auto parts into China, through the imposition of internal

charges. This serves to discourage the use of imported auto parts inside the

Chinese market than should be the case under China’s WTO commitments. To

give effect to the Measures, China has established various reporting requirements

1 In this submission, except where the Measures specifically provide for other categories of goods,

“parts” includes all auto parts and components associated with the production of whole vehicles or individual assemblies.

2 Accession Protocol (Exhibit JE-1). 3 The Measures are described in detail in section D1.

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that burden only those vehicle and auto parts manufacturers operating in China

that use imported auto parts. Moreover, the Measures adversely affect those

manufacturers by virtue of denying them the certainty of the rates set out in

China’s Schedule of Commitments4. Instead, those manufacturers that wish to

avoid these Chinese surcharges must re-align their investment decisions, to reflect

the additional costs and regulatory burdens imposed at all levels of the supply

chain.

4. Given that the objective and effect of the Measures is to encourage investors to

increase their investment in China’s domestic auto parts market instead of

importing auto parts, they are trade-related investment measures that violate

Article 2 of the Agreement on Trade Related Investment Measures (TRIMs

Agreement). Further, since Chinese and imported auto parts are like products, as

we demonstrate below, the Chinese measures violate Article III of the General

Agreement on Tariffs and Trade (GATT 1994) on the requirement to provide

national treatment to imports.

5. Even if the Chinese measures in question are properly considered border charges,

they violate China’s commitments under Article II of the GATT 1994: a given part

is not assessed based upon its HS code at presentation at the border, but is deemed

to be a whole vehicle, and generally charged a tariff at least 2 ½ times more than

the rate to which China committed in its Accession Protocol. In addition, this

treatment runs counter to China’s specific commitment in its Accession Protocol

that even if all parts necessary to assemble a vehicle were shipped together, they

would be charged at the (lower) parts rate.

6. China has also violated Article 3.1(b) of the Agreement on Subsidies and

Countervailing Measures (SCM Agreement) by providing a subsidy contingent

upon the use of domestic over imported auto parts. Vehicle manufacturers benefit

from lower internal charges on imported auto parts only if they satisfy local

content requirements.

4 Accession Schedule (Exhibit JE-2)

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7. The European Communities first sets out the background for this dispute,

describing the Measures in the context of the Chinese market for auto parts both

before and after accession to the WTO (Section II).5 We then examine the legal

consequences of the Measures, considering how the Measures are trade-related

investment measures, and inconsistent with the TRIMs Agreement (Section III.B).

We then demonstrate that imported auto parts are like domestic auto parts, and

how the less-favourable treatment offered to imported auto parts is inconsistent

with the various elements of Article III of the GATT 1994 (Section III.C). We then

address how the Measures can also be found to violate Article II of the GATT 1994

(Section III.D) before turning to the inconsistency of the Measures with Article 3.1

of the SCM Agreement (Section III.E).

II. BACKGROUND6

8. The net effect of the Measures is to discriminate between imported and domestic

auto parts so as to provide unfair advantage to domestic production, raising the

cost of foreign inputs and reducing the competitiveness of those vehicle

manufacturers that use them. The Complainants set out in detail how this

discrimination occurs. We begin by considering in general terms the auto parts and

vehicle manufacturing industry in China, together with the general regulatory

framework applicable to the imports of vehicles and auto parts. We will then

consider the Measures at issue and the WTO-inconsistent requirements that they

impose.

5 For the procedural background, the European Communities respectfully refers the Panel to the First

Written Submission of the United States. 6 The complaining Parties are submitting a common background section, which is reproduced

separately in the submission of each of the complaining Parties, and common exhibits, delivered with the submissions.

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China – Measures affecting imports of automobile parts First Written Submission WT/DS 339 by the European Communities ______________________________________________________________________

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A. Overview of Chinese Automotive Market

1. Vehicle production and sales

9. Vehicle production in China is, for all intents and purposes, like vehicle

production anywhere else in the world. It is a highly technical process, involving a

constant inflow of parts to manufacturing facilities in accordance with strict timing

requirements, so as to ensure that there is no delay in production chains. The

industry demands considerable logistical sophistication, particularly when

production of both parts and vehicles relies on long supply chains and the

integration of complex technologies across many countries and production

facilities.

10. The great majority of vehicles sold in China are produced by vehicle

manufacturers located in China. There are approximately 1,500 manufacturers

registered in China, of which fewer than 100 sell more than 10,000 vehicles a year.

Many small manufacturers sell only 300 to 500 vehicles a year.7

11. The top three producers of passenger vehicles in 2006 consisted of Sino-foreign

joint-ventures. Shanghai GM is the largest, selling 413,400 vehicles,8 followed by

Shanghai Volkswagen and FAW-Volkswagen selling 352,000 and 350,000

vehicles respectively. Chery, a Chinese-owned manufacturer of China’s top-

selling domestic brand has sales of 300,000 vehicles and is in fourth place.9

12. China’s focus on rationalisation has increased concentration in the industry, with

over 13 major producers responsible for 60% of current production. The

government's target for the domestic industry is to have just three or four major

producers by the year 2010.10

7 Asia Pulse, “Sino-foreign joint ventures top Chinese auto sales in 2006”, January 9, 2007 (Exhibit JE-

3). 8 Ibid. 9 See generally Global Insight Report (Exhibit JE-4) and Auto News 2006 for profiles of the major

joint-venture and domestic vehicle manufacturers (Exhibit JE-5). 10 Global Insight Report, at pp. 7 and 16 (Exhibit JE-4).

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13. There has been a boom in the sales of vehicles in China. In 2006, 7.22 million

vehicles were sold in China,11 up from approximately 2.5 million in 2001.12

Vehicle production in China has increased along with demand to 7.28 million

vehicles in 2006 (allowing China to displace Germany as the world’s third-largest

vehicle producer),13 from approximately 2.4 million vehicles in 2001.14

14. Chinese-owned vehicle manufacturers have been increasing their market share

over joint ventures with foreign manufacturers.15 Chinese-owned manufacturers

now have a 30% market share, as compared with 25% in 2005.16 Joint ventures

between foreign manufacturers and domestic Chinese companies account for the

vast majority of the remaining market share. Imported vehicles account for less

than 5% of the Chinese market.17

15. The growth in market share of Chinese-owned vehicle manufacturers is taking

place in an environment of increased sales and exports. Vehicle exports hit a

record high of 340,000 units in 2006, almost seven times more than 2004, with the

majority of them low-priced trucks and buses bound for developing markets in

Asia, Africa and Latin America. This focus on exports is part of the Chinese

government’s plan to increase automobile and auto parts exports to US $120

billion, or 10% of the world’s total vehicle trading volume, in the next ten years.18

11 Agence France Presse, “China auto sales seen spreading to smaller cities in 2007”, January 29, 2007

(Exhibit JE-6); BBC News, “Chinese car market is world No 2”, January 11, 2007, online: http://news.bbc.co.uk/2/hi/business/6252215.stm (Exhibit JE-7).

12 Global Insight Report, at p. 13 (Exhibit JE-4). 13 Asia Pulse, “China becomes world’s third largest auto producer in 2006”, January 17, 2007 (Exhibit

JE-8). 14 Global Insight Report, at pp. 13-15 (Exhibit JE-4). 15 People’s Daily Online, “China stands as world’s 2nd largest auto market”, January 13, 2006, online:

http://english.peopledaily.com.cn/200601/13/eng20060113_235259.html (Exhibit JE-9). 16 The Economist, “Carmaking in China: The fast and the furious”, November 25, 2006 (Exhibit JE-10);

Shanghai Daily, “China’s car industry on fast track”, December 27, 2006, “Market share of Chinese car brands such as Geely, Chery and Brilliance rose from 25 percent in 2005 to 30 percent this year, amid intensified competition from overseas giants”, online: http://en.ce.cn/Industries/Auto/200612/27/t20061227_9907488.shtml (Exhibit JE-11).

17 Asia Pulse, “Chinese auto makers race to the bottom”, February 8, 2007, (Exhibit JE-12), says 4% for 2006; Embassy of the People’s Republic of China in the United States, citing the People’s Daily’s Jan. 16, 2006 article, online http://www.china-embassy.org/eng/gyzg/t231212.htm ), says it is 160,000 out of almost 6 million, which is about 2.6% for 2006 (Exhibit JE-13).

18 Reuters, “China to introduce permits for auto exports”, January 3, 2007 (Exhibit JE-15); Industry News, November 2006, “China Plans To Up Auto Parts Exports By Ten Fold” Agence France Press, online: http://www.industryweek.com/ReadArticle.aspx?ArticleID=13111 (Exhibit JE-16).

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China – Measures affecting imports of automobile parts First Written Submission WT/DS 339 by the European Communities ______________________________________________________________________

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16. Pressure on pricing in China is intense, with automobile prices falling on average

by approximately 10,000 yuan (approximately US $1,250) per automobile each

year over the past several years.19 Heavy competition is continuing to lead to price

reductions in vehicle prices in China, with both existing and new models being

discounted.20 The industry’s average margin on sales fell to 4% percent in 2006.21

This pressure on prices (and on profits) is expected to continue over the short

term.22

17. As noted above in paragraphs 11 and 14, the top three vehicle manufacturers in

China are joint ventures, and overall joint ventures account for approximately 65%

of all vehicle sales in China. Foreign vehicle manufacturers are required to operate

entirely through joint ventures with a variety of restrictions, including minimum

investment, a maximum interest of 50% (except for joint ventures where the

production is destined for export) and a maximum number of joint ventures per

vehicle type.23

2. Auto parts production and sales

18. The auto parts market is highly fragmented, with the top ten manufacturers

accounting for only 20% of the total parts market in China of US $9.1 billion.

There are estimated to be 10,000 auto parts manufacturers in China,24 450 of

19 Agence France Presse, “Auto defects up in China amid price war”, November 20, 2006 (Exhibit JE-

17). 20 Auto News 2006, at p. 5 (Exhibit JE-5); Asia Times Online, “Chinese auto makers race to the bottom”,

February 9, 2007, online: http://www.atimes.com/atimes/China/GA07Ad01.html (Exhibit JE-12). 21 Auto News 2006, at p. 30 (Exhibit JE-5). 22 However, part of this expected drop in prices is based on an assumed reduction in tariffs for imported

parts, which will be limited if the Measures remain in place. See, for example, pp. 3 and 9 of the E&Y Report (Exhibit JE-14).

Page 3: “The [Economist Intelligence Unit] research suggests that fierce competition will drive down prices of Chinese-made vehicles, while the prices of imported cars will also fall sharply from 2006 as import tariffs are cut.”

Page 9: “Moreover, the price of these more technologically advanced cars should fall along with the phasing out of tariffs on imported components underpinning strong sales growth.”

23 Automotive Policy Order, Chapter X (Exhibit JE-18); KPMG China Report, at p. 6 (Exhibit JE-19); Global Insight Report, at p. 11 (Exhibit JE-4); Morgan Stanley report, “Chinese Auto Market: Reading the Tea Leaves”, February 17, 2004, at p. 24 online: www.uscc.gov/hearings/2004hearings/written_testimonies/04_09_23wrts/stephen_girsky.pdf (Exhibit JE-21).

24 Global Insight Report, at p. 19 (Exhibit JE-4).

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which are foreign-owned.25 Auto parts are produced in China both for use in

domestic manufacturing and for export. Chinese auto parts exports are substantial,

at over US $8 billion in 2004.26

19. [Deleted for confidentiality reasons]

20. Lower average prices have also led to pricing pressure on auto parts

manufacturers,27 particularly since parts constitute 80% of the vehicle cost in

China.28 This resulted in a drop in profit for parts manufacturers of [Deleted for

confidentiality reasons] in 2004 compared with 2003.29 Against this background,

China introduced the Measures challenged in these proceedings, providing

advantages to its domestic auto parts industry by discriminating against imported

auto parts – advantages that had existed in a similar form before China’s accession

to the WTO, but which were required to be removed.

B. Summary of Chinese Measures Favouring Domestic Content30 in the Automotive Industry prior to WTO Accession

21. Prior to China’s accession to the WTO, China imposed charges on imported auto

parts under its 1994 Automotive Industry Policy31 depending on the amount of

25 KPMG Asia Report, at p. 21 (Exhibit JE-20). 26 E&Y Report, at p. 11 (Exhibit JE-14). 27 KPMG China Report, at p. 15 (Exhibit JE-19). 28 Booz Allen Hamilton report, “The Road Ahead: China’s Passenger Vehicle Market in 2015”, March

2006, at p.4, online: http://www.boozallen.com/publications/article/1672938 (Exhibit JE-22). 29 Auto News 2005, at p. 25 (Exhibit JE-23). 30 The terms “domestic content” and “local content” are used interchangeably throughout this

submission. 31 Automotive Policy Order 1994, Articles 42-44 (Exhibit JE-24): Article 42 After introduction of a manufacturing technology from overseas, an automobile enterprise

must start its effort to localize the products therewith. The State takes the progress of localization of the import technology products as one of the conditions to support the enterprise to develop the second model.

Article 43 An automobile enterprise shall not engage in assembly through import of semi-knock-downs (SKD) or completely knock-downs (CKD).

Article 44 The State formulates preferential import tariff rates in accordance with the localization rate of automobile products. Those firms that reach the following localization standards may enjoy the different preferential tariff rates.

1. The localization rate reaches 40 percent, 60 percent or 80 percent in the products manufactured with the import technology for complete automobiles in Class M;

2. The localization rate reaches 50 percent, 70 percent or 90 percent in the products manufactured with the import technology for complete automobiles and motorcycles in Classes N and L; and

3. The localization rate reaches 50 percent, 70 percent or 90 percent in the products manufactured with import technology for unit assemblages or key parts and components.

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domestic content in assembled vehicles to promote local production of vehicles

and auto parts in China. China imposed higher charges on imported auto parts used

in the domestic production of parts or vehicles if the manufacturer importing those

auto parts did not meet certain domestic content in the final vehicle or auto part

that it produced.

22. There were four levels of charges. The lowest tariff was charged for manufacturers

that met very high levels of domestic content in their final production (more than

80% domestic content for M class vehicle, more than 90% for N and L class

vehicles or auto parts (assemblies and key components)). The highest charge was

imposed for manufacturers that had less than 40% domestic content (for

manufacturers of M class vehicles), or less than 50% domestic content (for

manufacturers of N and L class vehicles or auto parts).32

C. China’s Commitments in Relation to Auto Parts and Vehicles upon Accession to the WTO

23. China removed the Auto Policy 1994 as part of its Accession Protocol and

commitment to removing discriminatory charges on imported vehicles by the year

2000.33 China also committed to a Schedule of Concessions that, by July 1, 2006,

imposed a bound tariff rate on most auto parts at 10% or lower, and on most

vehicles at 25%.34

24. At the time it joined the WTO, China did not have a separate tariff line for auto

parts that were either fully or partly unassembled and that were shipped together

for assembly and further processing into a whole vehicle within China. Parts

shipped in this form are generally separated into two categories:

• “Completely knocked-down kits” (“CKDs”), are parts imported together in unassembled condition that provide the necessary parts in order to manufacture a whole vehicle. The kit may include not only parts, but also

32 Accession Protocol, Annexes 5A (pp. 71-72) and 5B (p. 92) (Exhibit JE-1); Dic Lo, Market and

Institutional Regulation in Chinese Industrialization, 1978-94 (New York: St. Martin’s Press, 1997), at p. 189 (Exhibit JE-25).

33 Accession Protocol, 10.1 to 10.3 (p. 7), Annexes 5A (pp. 70-72) and 5B (p. 92) (Exhibit JE-1). 34 Ibid., Part II, p. 11. The relevant HS codes, at the four-digit level, are: 84.09, 84.13, 84.14, 84.81,

84.82, 84.83, 85.11, 87.02, 87.03, 87.04, 87.06, 87.07, 87.08 and 90.32. A more detailed description of the Chinese tariff schedule is provided under section III.D.2.

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sub-assemblies and assemblies such as engine, transmission, axle assemblies, chassis and body assemblies.

• “Semi knocked-down kits” (“SKDs”) refers to partially assembled combinations of parts that can be used to manufacture a whole vehicle after manufacturing.

25. Prior to joining the WTO, China imposed substantially lower tariff rates on CKDs

and SKDs than on imported whole vehicles.35 China agreed that if it did introduce

a separate tariff line for CKDs or SKDs, the tariff rate would be no more than

10%.36

D. Introduction of New Measures

1. The Measures

26. In 2004-2005, China introduced a series of measures affecting imported auto parts

(“the Measures”). The overall effect of the Measures is to impose additional

internal charges on imported auto parts that are incorporated into vehicles for sale

in the domestic Chinese market when those parts are not combined with a

sufficient value or volume of domestic parts.

27. These Measures are:

a. The Policy on Development of the Automotive Industry, issued on May 21, 2004, by China’s National Development and Reform Commission (“NDRC”) as Order No. 8. (“Automotive Policy Order 2004”)

b. “Administrative Measures on Importation of Automotive Parts Deemed Whole Vehicles”, issued as Decree 125 on February 28, 2005 by China’s General Administration of Customs (“Customs”), NDRC, Ministry of Finance, and Ministry of Commerce in accordance with the Automotive Policy Order (“Decree 125”).

35 Dic Lo, Market and Institutional Regulation in Chinese Industrialization, 1978-94 (New York: St.

Martin’s Press, 1997), at p. 189 (Exhibit JE-25). 36 See, for commitment regarding CKDs and SKDs, the Working Party Report, at paras. 93 and 342

(Exhibit JE-26), and the Accession Protocol, Part I:1.2 (Exhibit JE-1).

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c. “Rules for Verifying whether Imported Automotive Parts are Deemed Whole Vehicles”, issued as Public Announcement No. 4 by Customs on March 28, 2005, in accordance with Decree 125 (“Announcement 4”).

2. Automotive Policy Order

28. Despite China’s commitment to a reduction in the tariff for imported auto parts in

its Accession Protocol, the NDRC issued the Automotive Policy Order on May 21,

2004. This returns China to its earlier practice of providing preferential treatment

for vehicle and auto parts manufacturers that favour domestic over imported

content in their production.

29. China issued the Automotive Policy Order with a view to achieving specific

objectives. Among those objectives, it is formulated to “meet … the new

circumstances for the development of the automotive industry at home and abroad

following accession to the World Trade Organization; in order to promote the

structural adjustment and upgrading of the automotive industry, and

comprehensively improve the international competitiveness of the automotive

industry”, and “… to develop [the country’s automotive industry] into a pillar

industry of the national economy by 2010”.37 The Automotive Policy Order also

provides that “[b]y 2010, our country is to become a major global automotive

manufacturing country, with automotive products that are able to satisfy most of

the domestic market’s demand and that have entered the international market in

large volumes”.38

30. With respect to the development of the auto parts industry, Article 4 of the Auto

Policy Order provides that an objective is to foster parts enterprises so that they

can “participate in the global auto parts supply chain as well as be internationally

competitive”. The nature of that “fostering” is specified in Article 31, which

provides that China will provide “priority support” for auto parts production and in

Article 52 which confirms that “[t]he State supports the efforts of vehicle

manufacturers to increase their domestic production capacity, giving impetus to

37 Automotive Policy Order, Preamble (Exhibit JE-18). 38 Ibid., Article 2.

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the technological progress of auto parts manufacturers and to the development

of the automotive manufacturing industry.”39

31. The method that China has chosen to ensure the localization of automotive and

auto parts production is set out in Chapter XI.40 Imported auto parts are charged

internally at the imported vehicle rate (which is generally at least 2 ½ times greater

than the parts rate)41 if the final vehicle in which they are used does not have

enough domestic content. This higher charge applies to imported auto parts

provided they are “Deemed Whole Vehicles”, despite China’s agreement to be

bound by the lower rate for auto parts in its Accession Protocol.

3. Decree 125 and Announcement 4

32. To implement and administer aspects of the Automotive Policy Order, China

promulgated Decree 125 and Announcement 4.

33. Decree 125 and Announcement 4, both made effective on April 1, 2005, are

legally binding instruments designed to implement and administer the Automotive

Policy Order. Decree 125, issued jointly by NDRC, Customs, the Ministry of

Finance and the Ministry of Commerce, governs when imported auto parts will be

Deemed Whole Vehicles and therefore assessed higher internal charges. They

apply directly to and affect choices of vehicle manufacturers importing parts to

produce vehicles for sale in the Chinese Market.42 They also indirectly affect auto

parts manufacturers through either Customs involvement or contractual

arrangements. This is because the manufacturers must record and track the value

and number of imported parts used in parts produced in China.43

39 Ibid., Article 52. 40 Ibid., Articles 53 to 57 and 60. 41 The final bound tariff rate for auto parts is generally 10%, while it is generally 25% for whole

vehicles. The 25% internal charge is effectively a payment of the 10% bound parts rate plus an additional 15%. In certain cases the amount may be as much as 12 ½ times more, such as for HS code 84099991 (parts for engines with an output of greater than 180 hp), where the Schedule commits China to a bound rate of 2%, but where a 25% charge could be imposed if the Measures apply (Exhibit JE-2).

42 Decree 125, Articles 2, 7 (Exhibit JE-27). 43 Ibid., Article 2; Announcement 4, Article 20 (Exhibit JE-28).

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34. Decree 125 effectively regulates the criteria used to determine when imported auto

parts are Deemed Whole Vehicles and are assessed an additional charge. It also

regulates the administrative procedures to which vehicle manufacturers are subject

under the Measures (both matters are explained below). Announcement 4 was

promulgated together with Decree 125, providing additional details on the

substantive criteria and administrative procedures that apply to vehicle and auto

parts manufacturers. Accordingly, the Measures work in conjunction with one

another.

35. There are no comparable internal charges that apply to domestic auto parts to

equalize the amount charged against imported auto parts under the Measures.

E. Substantive Criteria for Determining the Imposition of Internal Charges at the “Whole Vehicle” Rate

1. Determining whether Imported Parts are Deemed Whole Vehicles

36. The Measures apply to imported auto parts that are used in vehicles manufactured

for sale in the Chinese market.44 Vehicle manufacturers are required to file

information about the quantity or value of imported parts that they plan to use in a

particular vehicle model in order for Customs to determine whether the quantity or

value of imported parts used to manufacture a vehicle attains or exceeds certain

thresholds.45 If a vehicle model is found to have a certain quantity or value of

imported parts, as set out in detail in Decree 125 and Announcement 4, imported

auto parts are considered a “Deemed Whole Vehicle” and assessed at the higher

tariff rate for whole vehicles. This charge is not levied upon the importation of the

goods, but at a later date, after the vehicle has been manufactured.

37. A key concept in the Measures is that of “Assemblies” - which correspond roughly

to major parts of a vehicle. The Measures differentiate between two “main

Assemblies” and six other “Assemblies”:

44 Decree 125, Article 7, first sentence (Exhibit JE-27).

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Main Assemblies

1) the vehicle body (including driver’s cabin) Assembly; and 2) the engine Assembly.

Other Assemblies

1) the transmission Assembly; 2) the drive-axle Assembly; 3) the non-drive axle Assembly; 4) the chassis Assembly; 5) the brake Assembly; 6) the steering Assembly.46

38. Under the Measures, all imported parts will be Deemed Whole Vehicles and

therefore subject to internal charges that are generally at least 2 ½ times greater

than the bound rate for that part, if any of these three tests are met:

a. As of April 1, 2005, when complete CKD or SKD kits are imported to assemble a vehicle.47

b. As of April 1, 2005, if a sufficient number of Deemed Imported Assemblies48 are used in manufacturing the vehicle.49 Imported parts will be Deemed Whole Vehicles if the following combinations of Assemblies are “Deemed Imported”:

i) the two main Assemblies (the vehicle body and engine);

ii) either of the two main Assemblies as well as three or more other Assemblies; or

iii) five or more Assemblies, other than the main Assemblies.

c. As of July 1, 2006, when the aggregate price of imported parts reaches 60% or more of the price of the whole vehicle.50 However, this aspect of the Measures was suspended by Customs Joint Bulletin 38, dated July 5, 2006, until July 1, 2008.51

39. Under the Measures, then, imported parts can become Deemed Whole Vehicles on

the basis of the number of Assemblies built from imported parts or the value of

those imported parts.

45 The process of registering a model and related procedural steps under the Measures are set out in

more detail under the heading “Registration of vehicle models”, starting at para. 46. 46 See Decree 125, Articles 4, 21(2) and Annexes 1 and 2 (Exhibit JE-27); Announcement 4, Article 13

and Annex 2 (Exhibit JE-28). 47 Decree 125, Article 21(1) (Exhibit JE-27); Announcement 4, Article 13(1) (Exhibit JE-28). 48 The notion of Deemed Imported Assemblies is explained in Section 2 below. 49 Decree 125, Article 21(2) (Exhibit JE-27); Announcement 4, Article 13(2) (Exhibit JE-28).

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2. Determining whether Assemblies are Deemed Imported

40. An Assembly need not be imported in its entirety, or even manufactured in China

from exclusively imported parts to be “Deemed Imported” and thus to count

against the thresholds set out in the measures. Article 22 of Decree 125 specifies

that if any of the following configurations of imported auto parts are used in an

Assembly, it shall be Deemed Imported:

i) a complete set of parts is imported to assemble the Assembly;

ii) key parts are imported to assemble the Assembly, and these imported key parts attain and/or exceed the stipulated quantity criteria identified in Annex 1 of Decree 125.52 Further, as of July 1, 2008, lower quantity thresholds will apply to those key parts identified as of class A in Annex 1, and if exceeded, will make the Assembly Deemed Imported;53 or

iii) the aggregate price of imported parts is 60% or more of the total price of the Assembly in question.

41. Accordingly, an Assembly will be Deemed Imported under the Measures if any of

these three thresholds are met, which will then count towards calculating the

number of imported Assemblies listed in Article 21(2) of Decree 125. For

example, for a class M1 vehicle,54 the import of five key parts of the vehicle body

and six key parts of the engine will be sufficient to make both Deemed Imported

Assemblies and all imported parts Deemed Whole Vehicles. Further, from July 1,

2008 and the entry into force of the class A/B distinction, the imports of, e.g., two

doors, one engine block and one cylinder head will be sufficient to make the

vehicle body and the engine Deemed Imported Assemblies. This means that the

import of a relatively limited quantity or value of parts will be sufficient to treat

those parts as Deemed Whole Vehicles.

50 Decree 125, Article 21(3) (Exhibit JE-27), and Announcement 4, Article 13(3) (Exhibit JE-28). 51 Customs Joint Bulletin 38, July 5, 2006 (Exhibit JE-29). 52 See Decree 125, Article 22 and Annex 1 (Exhibit JE-27); Announcement 4, Article 19 and Annex 2

for this calculation (Exhibit JE-28). Further, Public Announcement 4, Article 20, specifies that if the price of the imported part of a key component or sub-assembly exceeds 60% of the price of the key component or sub-assembly then that key part or sub-assembly is deemed to be imported.

53 The entry into force of the class A/B distinction was initially foreseen on July 1, 2006 (Decree 125, Note 5 to Annex 1 (Exhibit JE-27), Announcement 4, Article 19 (Exhibit JE-28), but was suspended until July 1, 2008 by Customs Joint Bulletin 38 (Exhibit JE-29).

54 Vehicles used for transporting passengers and comprising no more than nine seats including the driver’s seat, Classification of Power-Driven Vehicles and Trailers (National Standard GB/T 15089-2001) (Exhibit JE-30).

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42. The only way to avoid imported parts becoming Deemed Whole Vehicles when

the import content thresholds under Articles 21 and 22 of Decree 125 are met

would be to engage in “substantial processing” in China.55 This results in the

imported parts being deemed domestic, and occurs in one of three ways:56

i) if there is an alteration of the tariff classification that results in a change to the four-digit tariff classification of the good pursuant to the PRC Import Tariff;

ii) if the price of the finished part is at least 30% higher than the price of the imported parts and raw material in the finished product; and

iii) if the manufacturing or processing performed in China is deemed to have created the basic properties of the finished product.

43. The principle of substantial processing applies to both parts directly imported by

vehicle manufacturers and to imported parts purchased by a manufacturer from a

domestic auto parts supplier. However, substantial processing alone of Assemblies

or key parts listed in Annex 1 of Decree 125 would not allow a vehicle

manufacturer to consider the imported parts or Assemblies as domestic, leaving

them no other option than to limit their imports.57

44. If the vehicle manufacturer produces a vehicle that uses imported parts which are

Deemed Whole Vehicles, then the manufacturer will be required to pay a charge

on all imported parts incorporated into the vehicle. That charge will be based on

the whole vehicle rate of 25%, and as noted above, will (together with the

appropriate tariff rate for the parts in question) result generally in internal charges

at least 2 ½ times the bound tariff rate for the imported parts.58

F. Additional Administrative Burden Imposed on Vehicle and Auto Parts Manufacturers under the Measures

55 Decree 125, Article 24 (Exhibit JE-27). 56 Announcement 4, Article 18 (Exhibit JE-28). 57 Decree 125, Article 24. The complainants understand that the principle of substantial processing

applies to imported parts incorporated into assemblies and key parts but does not apply to the processing of the assemblies or key parts themselves (Exhibit JE-27).

58 From 10% to 25%. In certain cases the amount may be as much as 12 ½ times more, such as for HS code 8409.99.91 (parts for engines with an output of greater than 180 hp), where China’s Schedule commits it to a bound rate of 2%, but where a 25% charge could be imposed if the Measures apply (Exhibit JE-2).

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45. In addition to the increased internal charges imposed when specified thresholds of

imported parts are used in automotive manufacturing, there are certain

administrative requirements imposed on manufacturers that use imported auto

parts. These administrative requirements are not applied with respect to domestic

auto parts and are considered in turn below.

1. Registration of vehicle models

46. Chapter II of Decree 125 sets out the required registration procedures to which

vehicle manufacturers are subject before they can obtain an automatic import

licence for auto parts.

47. Vehicle manufacturers must first perform a self-verification on proposed vehicle

models to determine whether the imported parts used in the vehicle models are

Deemed Whole Vehicles.59 Every vehicle model containing imported parts that are

Deemed Whole Vehicles after self-verification must then be reported to

Customs.60 Customs then registers the vehicle manufacturer and the vehicle

model.61

48. If the self-verification of a vehicle model is negative, then the vehicle

manufacturer is obliged to request a review of that model, which is carried out by

the National Centre for Verifying Deemed Whole Vehicles (the “Centre”) under

the authority of Customs. If the review shows that the vehicle model uses imported

parts that are Deemed Whole Vehicles, the vehicle model must be reported to and

registered with Customs (at the local Customs office).62

49. When applying to the NDRC for an “On-Road Motor Vehicle Manufacturer and

Product Announcement” and the Ministry of Commerce for a licence to import

auto parts, the vehicle manufacturer must provide its self-verification and the

review report from Customs if the imported auto parts are not Deemed Whole

59 Decree 125, Article 7 (Exhibit JE-27), and Announcement 4, Article 6 (Exhibit JE-28). 60 Decree 125, Article 9 specifies the information that a vehicle manufacturer must file, e.g., annual

production plans for the registered vehicle model, list of parts categories, price ratios of parts in the vehicle model being registered, item-by-item prices of domestic and imported parts, list of domestic and foreign suppliers (Exhibit JE-27).

61 Ibid., Articles 10 and 11.

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Vehicles. Licences granted for imported parts that are Deemed Whole Vehicles on

self-verification or review are marked with the words “Deemed Whole Vehicle”.63

50. Prior to the importation of auto parts, a vehicle manufacturer must provide the

local Customs office with a general duty guarantee (e.g., a letter of credit or

guarantee issued by a Chinese bank) where a vehicle model uses parts that are

Deemed Whole Vehicles. This guarantee cannot be lower than the average total

monthly duties payable on the quantity of parts to be imported by the

manufacturer.64 This amount is not based on actual imports but on the

manufacturer’s forecasted import plans. The general duty guarantee must be

adjusted if the manufacturer changes its import plans.65

2. Customs clearance and bonding requirements

51. Chapter III of Decree 125 sets out the customs procedures for importing auto parts

that are Deemed Whole Vehicles. Vehicle manufacturers must handle all customs

clearance procedures through the local Customs office and pay internal charges to

that office, even if the parts were imported through other ports of entry.66 Auto

parts imported through other ports of entry must apply to the local Customs office

for a “Customs to Customs transfer”.67

52. The Measures also establish that imported auto parts are subject to supervision by

Customs “as for bonded goods”, in effect deeming such imports as “in bond”.68

Bonding requirements would impose significant additional difficulties on auto part

and whole vehicle manufacturers, because Chinese law69 mandates that bonded

areas:

• may be established only with special permission;70

62 Ibid., Article 7. 63 Ibid., Article 7. 64 Ibid., Article 12. 65 Ibid. 66 Ibid., Article 13. 67 Ibid. 68 Ibid., Article 27. 69 Bonding Procedures (Exhibit JE-31); Warehouses Order (Exhibit JE-32). 70 Warehouses Order, Articles 7-13 (Exhibit JE-32).

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• have restrictions on the entry and exit, including special passes for personnel;71

• have special record-keeping requirements;72

• have a customs checking system installed, including computers connected to Customs;73 and

• restrict the movement of products, including treating movement out of the bonded area as an import, and requiring Customs approval for movement of products out of the area.74

53. In addition, in order for a company to operate a bonded warehouse, it must meet a

variety of requirements, including having a minimum amount of registered

capital.75

54. In practice, and despite the language of the Measures, the Chinese government has

not actually treated imported parts as bonded goods. Imported auto parts are used

freely at the manufacturing sites of vehicle and auto parts manufacturers with no

restrictions. Thus, to date, this deeming under the Measures is a fiction. However,

the risk remains that the Measures could be applied so as to impose significant

additional requirements, ostensibly linked to bonding requirements, and that

uncertainty provides a disincentive to use imported parts.

3. Verification procedures

55. Within ten days of the manufacture of the first batch of whole vehicles of a

registered model, the manufacturer must file specified documents with Customs.76

Then, within seven days of this filing, Customs must instruct the Centre to carry

out the verification.77 The verification must be done within one month of the

71 Bonding Procedures, Articles 3, 25 (Exhibit JE-31); Warehouses Order (Exhibit JE-32). 72 Bonding Procedures, Articles 5, 26 (Exhibit JE-31). 73 Ibid., Article 6; Warehouses Order, Articles 9(3), 15 (Exhibit JE-32). 74 Bonding Procedures, Articles 13, 27 (Exhibit JE-31); Warehouses Order, Articles 26-27 (Exhibit JE-

32). 75 Warehouses Order, Article 8(2) (Exhibit JE-32). 76 Decree 125, Article 19 (Exhibit JE-27); Announcement 4, Article 7 (Exhibit JE-28). The documents

which must be provided are: 1) application form for verification; 2) report of self-verification; 3) procurement list of parts; 4) document list for verifying Deemed Whole Vehicles; and 5) other documents as required.

77 Announcement 4, Article 8 (Exhibit JE-28).

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Centre receiving these instructions.78 Accordingly, a manufacturer may again incur

significant administrative delay in the final assessment of a charge as it could take

up to 48 days from submission of the application after the first batch of vehicles is

complete until the verification is actually carried out.

56. If a vehicle manufacturer objects to the results of the verification, a meeting is held

between the manufacturer, government officials and technical experts to determine

whether the Centre must perform a re-verification of the registered model.79

4. Payment of charges

57. One month after receiving the Verification Report, the vehicle manufacturer has

ten days to make a declaration for payment to the local Customs office.80 The local

Customs office then calculates the charges payable and levies them on the parts,

including any value-added tax payable, based on the Verification Report. Imported

auto parts are then assessed at the bound tariff rate (an import duty of generally

10% or less) plus a 15% internal charge if they are Deemed Whole Vehicles.81 If

the import duty has already been paid for a part, provided proof of payment is

supplied by the vehicle manufacturer, that amount will be deducted from the total

amount payable.82

58. If a subsequent verification report shows that a registered vehicle model no longer

uses imported parts that are Deemed Whole Vehicles, the manufacturer will no

longer be subject to the Measures’ cumbersome administrative procedures for that

particular model.83 Moreover, if a subsequent verification report shows that all

registered models no longer use imported parts that are Deemed Whole Vehicles,

the administrative measures will not apply to any vehicles produced by that

manufacturer and the general duty guarantee will be cancelled.84

78 Decree 125, Article 19 (Exhibit JE-27); Announcement 4, Article 9 (Exhibit JE-28). 79 Announcement 4, Article 12 (Exhibit JE-28). The re-verification must occur within one month of

instruction to the Centre to conduct it. 80 Decree 125, Article 31 (Exhibit JE-27). 81 Ibid., Article 28. 82 Ibid., Article 29. 83 Ibid., Article 32. 84 Ibid., Article 33.

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5. Additional procedural requirements in case of changes to the vehicle model or options fitted on the vehicle model

59. In addition to the general registration, self-verification and review procedures,

various additional procedural requirements are applicable if imported parts are

used instead of domestic parts.

60. The manufacturer must inform Customs and the Centre when a basic model

vehicle can be fitted with imported optional parts, and when such optional parts

are actually fitted to the vehicle.85

61. Equally, if the manufacturer wishes to introduce changes to the composition of the

basic model vehicle by increasing the number or proportion of imported parts, a

new verification process is due. Such changes may require the manufacturer to

register a new vehicle model and go through the entire process of self-verification,

review and verification by Customs.86

62. If domestic parts are used for the changes, it may not be necessary to register a

new vehicle model but only to go through a new verification, which may lead to

the vehicle model falling outside the scope of the Measures.87

6. Burden on auto parts manufacturers

63. As a result of Article 22 of Decree 125 and Article 20 of Announcement 4, the

level of imported content will have to be tracked down the chain of supply to

determine whether individual Assemblies and key parts are to be treated as

imported for purposes of the Measures. Such tracking will be made first at the

level of the Assembly to determine if the Assembly is Deemed Imported, and

subsequently at the level of “second-tier” suppliers for key parts.88

64. As a result, parts manufacturers and suppliers that use imported parts have to

maintain records of the quantity, type and cost of imported parts used in any parts

incorporated into a manufactured vehicle. They do this in order to meet their

85 Ibid., Article 20. 86 Announcement 4, Article 6 (Exhibit JE-28). 87 Decree 125, Articles 20 and 32 (Exhibit JE-27).

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contractual obligations to vehicle manufacturers and guarantee to them that they

meet the domestic content requirements of the Measures. They may also be

required to provide details to Customs about the purpose for which the imported

product will be used. This information may be provided directly to Customs or

indirectly by providing the information to the vehicle manufacturer.

65. These administrative requirements impose a significant logistical burden on all

users of imported parts and add the risk of financial penalties. Those penalties

could include:

• a fine for a violation of the Measures, or indirect penalties for making statements to Customs that are not properly substantiated;89

• financial loss resulting from internal charges under the Measures where records are insufficient to establish for Customs the requisite level of domestic content; and

• contractual penalties imposed by vehicle manufacturers to protect

themselves from the possibility of having to pay internal charges under the

Measures.

G. Example of Application of the Measures

66. We now consider how the Measures impose internal charges on identical parts

based on the use of the parts in China. To do so, we describe six hypothetical

imports into China of an identical product: brake master cylinders (hereafter

“brake cylinders”) for a light truck (HS 8708.39.40). The brake cylinders are

imported after July 1, 2006 – after the first two elements of the Measures came

into place, and after China’s tariff on that item dropped to 10% in accordance with

its Schedule. Those six separate imports, based upon the language in Decree 125

and Announcement 4, would have different treatment and internal charges under

the Measures. These hypothetical cases with additional variants are set out in

Table 1 below.

88 Announcement 4, Article 20 (Exhibit JE-28). 89 Decree 125, Article 36 (Exhibit JE-27); Order 63 (Exhibit JE-33).

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1. The first brake cylinder is destined for a retail store where it will be sold as a spare part for repairs. It is therefore not subject to the Measures and is charged the 10% tariff at the border.

2. The second brake cylinder is imported by an auto parts manufacturer, and is used in manufacturing a brake system Assembly. Also used in the manufacture of that brake system Assembly is an imported booster assembly, an imported front brake assembly and an imported rear brake assembly. Four “key parts” used in the manufacture of the brake system Assembly are imported, making it a Deemed Imported Assembly.90 The vehicle manufacturer performs a self-verification for a vehicle that it plans to produce, as required by the Measures.91 This shows that the brake system Assembly, engine Assembly and transmission Assembly would be Deemed Imported Assemblies within the meaning of the Measures. However, other Assemblies are largely sourced domestically. Since the vehicle contains only an engine Assembly and two other Assemblies that are deemed imported, imported parts will not fulfill the criteria for imposing the whole vehicle duty.92 Therefore, parts used in the Deemed Imported Assemblies, including the brake cylinder, are not charged additional amounts under the Measures. The brake cylinder has been charged a 10% tariff at the border, paid by the auto parts manufacturer, but the vehicle manufacturer is not required to make any additional payments.

3. The third brake cylinder is imported and incorporated into a vehicle in exactly the same situation as the second. However, as a result of sourcing difficulties, the vehicle in question is manufactured with an imported, rather than domestic, axle shaft. Another four parts of the drive-axle Assembly are imported, which, with the imported axle shaft, puts the imported content at the threshold of five “key parts”,93 meaning that the drive-axle Assembly becomes a Deemed Imported Assembly. Since the vehicle now contains an engine and three other Deemed Imported Assemblies, the imported auto parts are considered Deemed Whole Vehicles.94 The auto parts manufacturer therefore pays the 10% tariff for the brake cylinder at the border, but the vehicle manufacturer is then required to register a revised plan for the vehicles.95 This results in an

90 See Decree 125, Article 22(2), Annex 1 (Exhibit JE-27); Announcement 4, Article 14(2) and Annex

2, items 63-67 (Exhibit JE-28). 91 Decree 125, Article 7 (Exhibit JE-27). 92 Decree 125, Article 21(2)(b) (Exhibit JE-27); Announcement No. 4, Article 13(2)(ii) (Exhibit JE-28). 93 Decree 125, Article 22(2) and Annex 1 (Exhibit JE-27); Announcement 4, Article 14(2) and Annex 2,

items 44-53 (Exhibit JE-28). Note that pursuant to the Annex of Decree 125 the number of key parts for a drive axle for M1 vehicles is six, for other vehicles (M, M2, N) it is five. Light trucks are N vehicles (see Classification of Power-Driven Vehicles and Trailers – National Standard GB/T 15089-2001 (Exhibit JE-30)), and thus the key part threshold is five.

94 Decree 125, Article 21(2)(b) (Exhibit JE-27); Announcement 4, Article 13(2)(ii) (Exhibit JE-28). 95 Decree 125, Article 28 (Exhibit JE-27); Announcement 4, Articles 6 and 25 (Exhibit JE-28).

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additional internal charge of generally 15%96 on all imported parts used in the vehicle. 97

4. The fourth brake cylinder is imported in the reverse situation of the third: the plan registered by the vehicle manufacturer calls for the axle shaft to be imported, but a domestic supplier is found. Thus, the drive-axle Assembly, with only four key parts imported, is no longer deemed imported. The result is that the vehicle is no longer manufactured with enough Deemed Imported Assemblies to make the imported parts used in its manufacture Deemed Whole Vehicles. The vehicle manufacturer applies to Customs for re-verification of the vehicle. Assuming that the verification confirms that the drive axle is no longer a Deemed Imported Assembly,98, no additional internal charges are imposed. The charge on the brake cylinder is 10% payable by the auto parts manufacturer based on presentation at the border. The additional internal charge of 15% that would have been charged to the vehicle manufacturer based upon the registered plan is no longer required.99

5. The fifth brake cylinder is imported by an auto parts manufacturer who assembles an entire brake Assembly. On importation, the auto parts manufacturer pays a tariff of 10% of the value of the brake cylinder. The auto parts manufacturer has a contract with a vehicle manufacturer to provide brake Assemblies, with the requirement that the Assemblies have enough domestic content to avoid classification as Deemed Imported Assemblies. The auto parts manufacturer incorporates into the brake Assembly only three imported “key parts” (including the brake cylinder). It then calculates that the value of imported parts is 58% of the total value and concludes that the Assembly is not a Deemed Imported Assembly. The brake Assembly is shipped to a vehicle manufacturer which uses it to manufacture a vehicle together with an engine, transmission and axle that are Deemed Imported Assemblies. On the strength of the information from the auto parts manufacturer, the vehicle manufacturer conducts a self-verification and determines that the vehicle is not using imported parts that are Deemed Whole Vehicles. However, on verification, the Centre determines that the value of imported parts incorporated into the brake Assembly is actually 61%.100 The vehicle manufacturer is required to pay an additional internal charge of 15% on all imported auto parts used in the vehicle (including those used in the engine, transmission, axle and brake

96 As noted earlier, in fn. 41, the final rate bound in China’s schedule is 10% for most auto parts, but is

lower for certain parts, going as low as 2%. 97 Decree 125, Article 28 (Exhibit JE-27). Note that it is possible that the whole 25% is paid after

verification, as suggested in Article 29, which allows for the deduction of duties already paid, but suggests that it will not always have occurred.

98 Decree 125, Article 20, second paragraph (Exhibit JE-27). 99 Ibid., Article 28. 100 There are myriad ways that there could be differences in calculation, but, to take one example, there

could be a different interpretation about whether certain domestically sourced oils and liquids should be included in the calculation of domestic content (see Announcement 4, Article 24, which speaks of which oils and liquids can be included in the calculation (Exhibit JE-28)).

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Assemblies).101 Depending on the wording of the contract between the auto parts manufacturer and the vehicle manufacturer, the former may be required to reimburse the latter for some or all of those internal charges.

6. The sixth brake cylinder is imported as part of a CKD. This is done because the vehicle in question has a very limited market in China, so it is not economical to have a production line established solely for that model. The parts are assembled in China at a facility that also manufactures wholly domestic vehicles. The imported parts are Deemed Whole Vehicles, and the vehicle manufacturer is required to pay a total of 25% of their value.102

101 Decree 125, Articles 21(2)(b) and 28 (Exhibit JE-27); Announcement 4, Article 13(2)(ii) (Exhibit JE-

28). 102 Decree 125, Article 21(1) (Exhibit JE-27).

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Table 1 – Illustration of application of the Measures to imported brake cylinders for a light truck

This chart sets out the six scenarios set out in the text above, as well as variations of those scenarios.

Scenario Final use of imported

brake cylinder Used in an Assembly?

Brake Assembly Deemed Imported?

Number of main Assemblies Deemed Imported in the final vehicle

Number of other Assemblies Deemed Imported in the final vehicle*

Imported parts Deemed Whole Vehicles?

Duty charged on import

Additional internal charges paid after import

1 Retail Sale No N/A N/A N/A N/A 10% None 2 In vehicle self-

verified by manufacturer as not using parts Deemed Whole Vehicles

Yes Yes 1 2 No 10% None

2 (variant)

The body is also a Deemed Imported Assembly –everything else is the same

Yes Yes 2 2 Yes 10% 15%

2 (variant)

The body is also a Deemed Imported Assembly – brake Assembly has less imported parts and therefore not a Deemed Imported Assembly

Yes No 2 1 Yes 10% 15%

3 In vehicle whose model is self-verified by manufacturer as not using imported parts Deemed Whole Vehicles, but in which the drive-axle assembly becomes Deemed Imported following problems of supplies

Yes Yes 1 3 Yes 10% 15%

3 (variant)

Engine is not Deemed Imported – everything else is the same

Yes Yes 0 3 No 10% None

3 (variant)

Engine is not Deemed Imported, but two other Assemblies are

Yes Yes 0 5 Yes 10% 15%

4 In vehicle found on verification not to use imported parts Deemed Whole Vehicles

Yes Yes 1 2 No 10% None

4 (variant)

The Centre finds that the axle Assembly is still a Deemed Imported Assembly

Yes Yes 1 3 Yes 10% 15%

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Scenario Final use of imported brake cylinder

Used in an Assembly?

Brake Assembly Deemed Imported?

Number of main Assemblies Deemed Imported in the final vehicle

Number of other Assemblies Deemed Imported in the final vehicle*

Imported parts Deemed Whole Vehicles?

Duty charged on import

Additional internal charges paid after import

4 (variant)

Verification determines that another Assembly (e.g., the vehicle chassis) has 61% foreign content

Yes Yes 1 3 Yes 10% 15%

5 In vehicle found on verification to use imported parts Deemed Whole Vehicles

Yes Yes 1 3 Yes 10% 15%

5 (variant)

On re-verification (Announcement 4, Article 12), foreign content of brake Assembly found to be 59%

Yes No 1 2 No 10% None (or refund of 15% paid)

6 In a shipment together with all parts for a whole vehicle (a CKD) – all parts are assembled into a whole vehicle by the vehicle manufacturer

Yes Yes 2 5 Yes 25% None

6 (variant)

All parts for a whole vehicle are imported by a vehicle manufacturer, but are sourced from different suppliers and shipped in at different times

Yes Yes 2 5 Yes 10% 15%

* Including the Brake Assembly, if it is Deemed Imported.

67. As these examples demonstrate, the key factor in determining the amount charged

on an imported auto part is the use to which it is put in China.

H. Impact of the Measures

68. The Chinese vehicle and auto parts market is changing rapidly as a result of a

variety of factors, including increasing vehicle sales, changing consumer

preferences, concerns regarding overcapacity in vehicle production in China, and

corporate strategy of foreign and domestic manufacturers. In the context of these

factors, a review of the present market situation shows that the Measures skew the

choice of manufacturers towards the use of domestic auto parts.

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69. On April 1, 2006, a new tax was imposed on cars with engines of 2.0-litre or

larger. The new tax structure imposes charges of between 9 and 20 percent of the

purchase price, while simultaneously cutting the existing tax on cars with engines

smaller than 2.0 litres. This tax added further pricing pressure, forcing

manufacturers to determine whether they could pass along the increased cost to

consumers, or whether to suffer a further diminution in margins. [deleted for

confidentiality reasons]

70. Due to the price-sensitivity of the Chinese market, vehicle and auto part

manufacturers (both foreign and domestic) in many cases would be “priced out” of

the Chinese marketplace in cases where the Measures force them to pass on the

additional 15% internal charges on imported parts to their customers. Due to low

profit margins on vehicle and parts manufacturing in the Chinese automotive

market, neither vehicle nor auto parts manufacturers can absorb the additional

15% internal charge.

71. As a result of the heavy pricing pressures in the existing Chinese market,

manufacturers are forced to maximize domestic content in their parts and vehicles

so as to avoid a finding that a vehicle uses imported parts that are Deemed Whole

Vehicles.

72. In addition, foreign vehicle manufacturers invested in the Chinese marketplace on

the premise that they would be able to import parts as required at the rates to

which China bound itself in its Schedule. Accordingly, the addition of an internal

charge of 15% of the value of imported parts, and the consequent commercial

uncertainty, significantly devalues their investment in China.

73. Even where an imported auto part is commercially superior, a vehicle

manufacturer must secure a minimum amount of domestic substitutes of higher

price or lower quality, in order to avoid the internal charges imposed by the

Measures. If not, it risks significant losses or devaluation of its investment in the

automotive industry.

74. The requirements of vehicle manufacturers imposed in order to avoid additional

internal charges under the Measures introduce difficulties for the auto parts

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manufacturer that must locate a domestic source for such parts. These

requirements also make it less attractive to use imported product otherwise equal

to or better than domestic product, since use of that imported product may cause

the manufacturer to exceed contractual thresholds for domestic content, resulting

in financial penalty.

III. LEGAL ARGUMENT

A. Preliminary considerations

75. In this section the European Communities develops its legal argument in detail.

The European Communities considers that the Measures are inconsistent with a

number of obligations under the agreements on the basis of which the European

Communities has requested the establishment of the Panel.

76. The arguments are presented in the light of the Appellate Body report in EC –

Bananas III, where it considered that the agreements that are more specific to the

matter before the Panel should be considered first. 103 Therefore the claims and

arguments will be presented in the following order:

- the TRIMs Agreement (section B) - Article III of the GATT 1994 (section C) - Article II of the GATT 1994 (section D). - the SCM Agreement (section E).

103 Appellate Body Report, EC – Bananas III, paras 202-204.

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B. The Measures are inconsistent with the agreement on Trade Related Investment Measures ("TRIMs") and the terms and conditions of China's accession to the WTO on TRIMs

1. Introduction

77. According to Article 1 of the TRIMs Agreement, the agreement applies to

investment measures related to trade in goods only (referred to in the Agreement

and hereafter as "TRIMs").

78. Article 2 of the TRIMs Agreement is entitled "national treatment and quantitative

restrictions". According to paragraph 1 of Article 2

Without prejudice to other rights and obligations under GATT 1994, no Member shall apply any TRIM that is inconsistent with the provisions of Article III or Article XI of GATT 1994.

79. Paragraph 2 of Article 2 in turn states that

An illustrative list of TRIMs that are inconsistent with the obligation of national treatment provided for in paragraph 4 of Article III of GATT 1994 and the obligation of general elimination of quantitative restrictions provided for in paragraph 1 of Article XI of GATT 1994 is contained in the Annex to this Agreement.

80. Although in Indonesia – Autos the panel considered that "on its face the TRIMs

Agreement is a fully fledged agreement in the WTO system" it is clear that it also

interprets and clarifies the provisions of Article III and Article XI of GATT 1994

where trade-related investment measures are concerned.104 Furthermore, by

concluding the TRIMs Agreement and attaching to it the Illustrative List, the

Members have defined certain trade related investment measures that are per se

inconsistent with Article III:4 or Article XI:1 GATT.

81. In the following sections the European Communities will demonstrate that the

Measures are inconsistent with Article 2 of the TRIMs Agreement in conjunction

with paragraph 1(a) and 2(a) of the Illustrative List. As China has also specifically

undertaken to comply with the TRIMs Agreement in its Protocol of Accession to

104 Panel Report, Indonesia – Autos paras 14.61 and 14.62.

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the WTO, the Measures are consequently also inconsistent with its obligations

under the WTO Agreement.

2. The Measures are inconsistent with Article 2 of the TRIMs Agreement in conjunction with paragraph 1 (a) of the Illustrative List annexed thereto

(a) Introduction

82. In Indonesia – Autos, the panel considered that Article 2.1 of the TRIMs

Agreement requires two elements to be shown to establish a violation thereof: first,

the existence of a TRIM; second, that the TRIM is inconsistent with Article III or

Article XI of GATT. The first part of the test requires the fulfilment of two

conditions, namely that the measures are "investment measures" and that they are

"trade-related".105

83. As regards the second element of the test, paragraph 1(a) of the Illustrative List in

the annex to the TRIMs Agreement states that

TRIMs that are inconsistent with the obligation of national treatment provided for in paragraph 4 of Article III of GATT 1994 include those which are mandatory or enforceable under domestic law or under administrative rulings, or compliance with which is necessary to obtain an advantage, and which require:

(a) the purchase or use by an enterprise of products of domestic origin or from any domestic source, whether specified in terms of particular products, in terms of volume or value of products, or in terms of a proportion of volume or value of its local production.

…..

84. Consequently, it will first be shown that the Measures are "investment measures"

followed by a demonstration that the Measures are "trade-related". Third, the

European Communities will show that the Measures fall squarely within the scope

105 Panel Report, Indonesia – Autos paras 14.67, 14.71 and 14.72. It had been argued before the panel

that any measure that falls within the description of Item 1(a) of the Illustrative List of the TRIMs Agreement constitutes per se a TRIM inconsistent with Article 2 of the TRIMs Agreement. The panel declined to answer this basic question and decided rather to use the general two stage test described above.

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of paragraph 1 (a) of the Illustrative List as they require compliance with local

content thresholds to obtain a number of advantages.

(b) The Measures are "investment measures"

85. It should first be demonstrated that the Measures constitute (a) TRIM(s) under

Article 1 of the TRIMs Agreement.106

86. The Automotive Policy Order107 is, as a whole, a measure that aims at encouraging

the development of a local manufacturing capability for finished motor vehicles

and parts and components in China. Throughout the text of this measure reference

is made to the development of the local automotive industry both as regards

complete vehicles and automotive parts. Thus, it is a measure that can generally

affect investment.

87. The following are just illustrative examples of general investment related

provisions in the Automotive Policy Order:

Article 2, last sentence

By 2010, our country is to become a major global automotive manufacturing country, with automotive products that are able to satisfy most of the domestic market's demand and that have entered the international market in large volumes.

Article 4, first and last sentences

Promote structural adjustments and restructuring in the automotive industry, increase enterprises' economies of scale, improve industrial concentration, avoid a dispersed, chaotic, low-grade and redundancy-prone build-up.

….

Nurture a group of relatively strong auto-parts manufacturers to achieve large-scale production such that they are able to participate in the global auto parts supply chain as well as be internationally competitive.

106 Panel Report, Indonesia – Autos, paragraph 14.72. 107 Exhibit JE – 18.

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Article 5

The State directs the formulation of the industry’s development planning in accordance with the Policy on Development of the Automotive Industry. The development planning includes medium- and long-term development planning for the industry and development planning for large vehicle manufacturers. Medium- and long-term development planning for the industry are drawn up by the National Development and Reform Commission ("NDRC") jointly with other relevant departments on the basis of widely solicited opinions, and submitted to the State Council for approval and implementation. Large vehicle manufacturers are to formulate the corporation’s proper development planning in conformity with the medium- and long-term development planning for the industry.

Article 6

A corporation with characteristics including unified planning, autonomously developed products, an independent product trademark and brand and an integrated sales and services system management, and of which, moreover, the automotive products produced by its core enterprise and/or wholly-owned subsidiaries, holding companies and Sino-foreign joint venture enterprises have a domestic market share of 15% or more, or whose annual sales revenue from whole vehicles accounts for 15% or more of the entire industry’s annual whole vehicles sales revenue, is entitled, as a “large automotive enterprise corporation”, to draw up and submit the corporation’s development planning independently, for implementation after validation and approval by NDRC.

Article 14

Manufacturers of whole vehicles should in the process of structural adjustment increase their level of specialized production, and gradually transform parts-producing units supplying in-house needs into open market-oriented, independent specialized parts-manufacturers. (Emphasis added)

88. Chapter VIII (Articles 30 to 32) provides for more detailed principles on

automotive parts and related industries whereas Chapter X of the Automotive

Policy Order is specifically entitled "Investment Management".

89. Chapter XI (Article 52 to 60) deals specifically with import management.

According to Article 52

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The State supports the efforts of vehicle manufacturers to increase their domestic production capacity, giving impetus to the technological progress of auto parts manufacturers and to the development of the automotive manufacturing industry. (Emphasis added)

90. Decree 125108 is, according to its preamble an implementing measure under and

adopted in accordance with the Automotive Policy Order. It provides for more

detailed rules in particular for the implementation of the import management

provisions of the Automotive Policy Order. Its contents have already been

described in detail in sections II D.3, E and F above.

91. Announcement 4109 provides for the rules to regulate the procedures for verifying

whether imported automotive parts are Deemed Whole Vehicles. According to its

introductory paragraph, it constitutes a complement to the Administrative

Measures on Importation of Automotive Parts that are Deemed Whole Vehicles.

Its contents have also been described in detail under sections II D.3, E and F

above.

92. The European Communities is of the view that already the brief description of

some of the provisions of the Measures above demonstrates that they are aimed at

encouraging the development of a local manufacturing capability for finished

motor vehicles and parts for motor vehicles in China. Inherent to this objective is

that these Measures necessarily have a significant impact on investment in these

sectors. The whole investment strategy of both local and foreign vehicle and part

manufacturers is governed by the constraints laid down by these Measures. The

European Communities therefore considers that the Measures are "investment

measures" within the meaning of the TRIMs Agreement.

(c) The Measures are "trade-related"

93. The Measures apply and relate only to imported parts. This necessarily means that

they are trade-related.

108 Exhibit JE – 27. 109 Exhibit JE – 28.

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94. Furthermore, in Indonesia - Autos, the panel considered that local content

requirements are necessarily "trade-related" because such requirements, by

definition, always favour the use of domestic products over imported products, and

therefore affect trade.110

(d) The Illustrative List

95. An examination of whether the Measures are covered by paragraph 1 (a) of the

Illustrative List, which refers inter alia to measures with local content

requirements, will not only indicate whether they are trade-related but also

whether they are inconsistent with Article III:4 of the GATT and thus in violation

of Article 2.1 of the TRIMs Agreement.111

i) Local content requirements

96. Pursuant to paragraph 1 (a) of the Illustrative List annexed to the TRIMs

Agreement a local content requirement will necessarily be inconsistent with the

obligation of national treatment provided for in paragraph 4 of Article III of GATT

1994. Measures with such requirements will consequently also be inconsistent

with Article 2.1 of the TRIMs Agreement.

97. The precise text of paragraph 1 (a) of the Illustrative List refers to

the purchase or use by an enterprise of products of domestic origin or from any domestic source, whether specified in terms of particular products, in terms of volume or value of products, or in terms of a proportion of volume or value of its local production.

98. The Measures fall squarely within this description. First, the only way not to be

constrained by the procedural and substantive requirements of the Measures is to

ensure that all the parts that make up the complete vehicle model are locally made

in China. A vehicle model 100 % made of Chinese parts will never be subject to

the Measures.

110 Panel Report, Indonesia – Autos, para 14.82. 111 Panel Report, Indonesia – Autos, para 14.83.

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99. Second, once parts are imported for the production of a given model and the

measures apply, the imported parts may be "Deemed Whole Vehicles" on the basis

of the substantive criteria laid down in particular under Chapter XI (Articles 52 to

60) of the Automotive Policy Order, Articles 21 to 24 of Decree 125 and Chapter 3

(Articles 13 to 24) of Announcement 4. These criteria have been described in

detail in section II E above.

100. If imported parts are Deemed Whole Vehicles, the Measures impose on them an

additional internal charge of generally 15 %. The automobile manufacturers will

also be subject to additional procedural requirements. The qualification of

"Deemed Whole Vehicles" is directly dependent on the value or amount of

domestic parts used in combination with the imported parts to manufacture the

vehicle.

101. Consequently, the only way to escape the imposition of the additional internal

charge of typically 15 % of the value of the imported parts and the additional

procedural constraints is to guarantee that the vehicle models concerned contain a

sufficient combination, number and/or proportion of locally manufactured parts.

Because of the uncertainties relating to the valuation of the products under the

Measures112, the cumbersome procedures and the complex substantive criteria for

assessing whether the vehicle models contain imported parts that are "Deemed

Whole Vehicles", automobile manufacturers will have to ensure that there is

always a sufficient safety margin between the level of domestic parts incorporated

in the vehicle models and the required level of local content. However, already on

the face of the measures, imported parts must not make up more than 60 % of the

price of the whole vehicle in order not to be subject to the imposition of the

additional internal charge.

102. The automobile manufacturers must therefore ensure that they use domestically

made products in a sufficient combination, number and/or proportion of the parts

that make up the complete vehicle. In reality most, if not all, automobile

manufacturers that use imported parts in the first place will try to ensure that their

112 For instance, there could be a different interpretation about whether certain domestically sourced oils

and liquids should be included in the calculation of domestic content (see Announcement 4, Article 24, which speaks of which oils and liquids can be included in the calculation).

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vehicle models are manufactured in a way that in all cases the imposition of the

additional internal charge of typically 15 % is avoided. Otherwise they will simply

not be competitive on the market.

103. Third, the Measures restrict the operational flexibility of the manufacturer in many

ways, which provides further incentives to use local parts instead of imported

parts.

104. Under Article 6 of Announcement 4, an automobile manufacturer that has already

complied with the Measures, but needs subsequently to change the percentage

make-up of imported parts so that they become "Deemed Whole Vehicles", will

have to register the vehicle model as a new model with the attached consequence

of becoming subject to the additional internal charge. Equally, should it be

possible to fit imported optional parts on the basic-model vehicle, such optional

parts will trigger a declaration obligation and re-verification by Customs (Article

20 of Decree 125). All such changes may lead to the imposition of the additional

internal charge.

105. All this has the necessary consequence that the automobile manufacturers will try

to avoid making changes to their models using imported parts.

106. The European Communities is therefore of the view that the Measures require "the

purchase or use by an enterprise of products of domestic origin or from any

domestic source, whether specified in terms of particular products, in terms of

volume or value of products, or in terms of a proportion of volume or value of its

local production" within the meaning of paragraph 1 (a) of the Illustrative List to

the TRIMs Agreement to obtain the advantages described in detail below.

ii) "Compliance with which is necessary to obtain an advantage"

107. The European Communities considers that the Measures fulfil the second criterion

"compliance with which is necessary to obtain an advantage" in the chapeau of

paragraph 1 of the Illustrative List. The Measures provide for a number of

advantages on condition that local parts are used instead of imported parts. These

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advantages can be separated into two categorises namely lower charges on the one

hand and procedural advantages on the other hand.

108. As stated by the Panel in Indonesia – Autos, "the wording of the Illustrative List of

the TRIMs Agreement makes it clear that a simple advantage conditional on the

use of domestic goods is considered to be a violation of Article 2 of the TRIMs

Agreement even if the local content requirement is not binding as such"113.

♦ Lower charges as an advantage

109. As described in detail under section II F.4, if an insufficient amount or value of

domestic parts are used in the assembly and manufacture of the vehicle model,

imported automotive parts will be subject, in addition to the import duty applicable

to the part in question (typically 10 % or less) under the bound tariff rates of

China, to an internal charge equal to the difference between the whole vehicle

import duty (typically 25 %) and the duty applicable to the part or accessory in

question. In the most typical situation, this additional charge amounts to 15 % of

the value of the imported parts.

110. If the manufacturer imports parts for the manufacture of a given vehicle model, the

only way to avoid the imposition of this additional internal charge is to comply

with the local content rules examined above.

111. As already stated by the Panel in Indonesia – Autos, lower tax and duty rates are

clearly "advantages" in the meaning of the chapeau of paragraph 1 of the

Illustrative List.114

112. The European Communities therefore considers that the possibility to avoid the

additional internal charge is clearly an "advantage" within the meaning of the

chapeau of paragraph 1 of the Illustrative List to the TRIMs Agreement.

113 Panel Report, Indonesia – Autos, para 14.90. 114 Panel Report, Indonesia – Autos, para 14.89.

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♦ Procedural advantages

113. The Measures provide for three levels of procedural advantages depending on how

the manufacturer complies with them.

114. First, one way of complying with the local content requirements contained in the

Measures would be to only use domestic parts in the manufacture of vehicles. In

addition to the advantage of definitely escaping the additional internal charge, the

cumbersome administrative procedures under the Measures will not be applicable

if only Chinese made parts are used in the manufacture of the vehicle model.

These procedures have been described in detail in the Background section above

(see section II F above).

115. Second, for automobile manufacturers subject to the Measures, the respect of the

local content requirements will entail the advantage of escaping part of the

administrative burden. Indeed, part of the administrative requirements will apply

only when the local content requirements are not fulfilled and the imported parts

are Deemed Whole Vehicles. In such a case, and after self-verification, the

automobile manufacturer will need to register the vehicle model using parts being

Deemed Whole Vehicles (Article 7 of Decree 125) and establish a Customs duty

guarantee (Article 12 of Decree 125) prior to any import and apply for and

undergo verification of the first batch of vehicles produced (Article 19 of Decree

125). Failure to comply with these procedural obligations will lead to the

revocation of the On-Road Motor Vehicle Manufacturer and Product

Announcement for the vehicle model concerned until the manufacturer has

rectified the situation (Article 37 of Decree 125).

116. Third, the Measures impose, in addition to the general registration, self-

verification and review procedures, various additional procedural requirements

that will become applicable if imported parts are used instead of locally made

parts. Indeed, pursuant to Article 20 of Decree 125, if imported parts can

optionally be fitted on the basic model vehicle, the manufacturer must provide the

Customs and the Center with information on the type of optional modifications

and report when optional imported parts are fitted on. There is no such obligation

if the optionally fitted part is domestic. Equally, if the manufacturer wishes to

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introduce changes to the composition of the basic model vehicle by increasing the

number/proportion of imported parts, a new verification process is due. According

to Article 6 of Announcement 4, such changes may require the manufacturer to

register a new vehicle model and go through the entire process of self-verification,

review and verification by Customs etc. If locally made parts are used for the

changes, it may not be necessary to file a new vehicle model but only go through a

new verification. These procedures have been described more in detail above in

section II F.5 above.

117. Such constraints influence in a considerable manner the investment strategy of the

manufacturers and put their operations under a very strict "straight-jacket". This

puts the imported parts in a clear disadvantage as they cannot be used freely in the

development of vehicle models. Furthermore, the manufacturers cannot have

flexible contingency plans in case of shortage of or difficulties with supplies, and

cannot respond to customers' demands to have imported options fitted on the basic

model without considerable administrative and potentially fiscal consequences that

threatens their whole investment strategy in China. By using locally made parts for

any changes to the vehicle model or fitting locally sourced options on the basic

model vehicle, car manufacturers may regain some flexibility in the development

of their models.

118. Such an increased flexibility to modify the composition of the vehicle model and

the possibility to offer customers the choice of fitted options on the basic model

without additional administrative and procedural consequences is a considerable

advantage.

119. Consequently, the European Communities considers that the Measures provide for

various ways to obtain procedural advantages all of which require the purchase or

use by the manufacturer of parts of Chinese origin or from Chinese source within

the meaning of paragraph 1 of the Illustrative List to the TRIMs Agreement. Such

advantages range from the avoidance of all the procedural requirements to various

flexibilities at different stages of the application of the Measures as described

above.

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(e) Conclusion

120. The European Communities has demonstrated above that all the elements to find

an inconsistency between the Measures and Article 2 of the TRIMs Agreement, in

conjunction with paragraph 1 (a) of the Illustrative List annexed thereto, are

fulfilled.

3. The Measures are inconsistent with Article 2 of the TRIMs Agreement in conjunction with paragraph 2 (a) of the Illustrative List annexed thereto

(a) Introduction

121. It has been demonstrated above that the Measures are inconsistent with Article 2

of the TRIMs Agreement in conjunction with paragraph 1 (a) of the Illustrative List

annexed thereto.

122. However, the Measures are also inconsistent with Article 2 of the TRIMs

Agreement in conjunction with paragraph 2 (a) of the Illustrative List annexed

thereto.

123. In such an analysis the measures are examined from the point of view of their

impact at the border. In other words, the measures are examined for the purposes

of whether they introduce quantitative restrictions on imports.

(b) The Measures fall squarely within the description in paragraph 2 (a) of the Illustrative List

124. Paragraph 2(a) of the Illustrative List in the annex to the TRIMs Agreement states

that

TRIMs that are inconsistent with the obligation of general elimination of quantitative restrictions provided for in paragraph 1 of Article XI of GATT 1994 include those which are mandatory or enforceable under domestic law or under administrative rulings, or compliance with which is necessary to obtain an advantage, and which restrict:

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(a) the importation by an enterprise of products used in or related to its local production, generally or to an amount related to the volume or value of local production that it exports;

--------.

125. As was already described above in paragraphs 107-119, the effect of the Measures

is to require companies to use automotive parts manufactured in China in order

either to avoid the threat of being subject to the various procedural requirements

under the Measures or, as the case may be, to avoid the imposition of the typically

15 % internal charge and the threat of additional procedural requirements.

126. Such local content requirements have, by definition, considerable effects on the

importation of products used or related to its local production. An automobile

manufacturer that wishes to avoid the stringent administrative procedures of the

Measures, including the loss of flexibility in the development and marketing of the

vehicles it produces, will seek to avoid importing any automotive parts at all.

127. Equally, even if the enterprise wishes or, for technical and/or logistical reasons,

needs to import parts for the assembly and manufacture of vehicles, the Measures

compel it to minimise such imports under the threat of additional charges being

imposed on the imported parts that make up the complete vehicle. The only way to

obtain the advantages of not being subject to additional burdensome procedural

constraints and/or not being subject to an additional internal charge is to generally

restrict the imports of parts used in or related to the manufacturing of vehicles in

China.

128. It has also been demonstrated above (see paras. 85-94) that the Measures are

"investment measures" and that they are also "trade related". In the view of the

European Communities, the Measures fall consequently also within the definition

contained in paragraph 2(a) of the Illustrative List annexed to the TRIMs

Agreement and are therefore inconsistent with paragraph 1 of Article XI GATT

1994. Consequently, they are inconsistent with Article 2 of the TRIMs Agreement

in conjunction with paragraph 2 (a) of the Illustrative List annexed thereto.

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4. The Measures are inconsistent with China's obligations under the WTO Agreement, as set out in the Protocol of Accession of the People's Republic of China to the WTO

(a) The terms of China's accession to the WTO

129. According to Article XII:1 of the WTO agreement

Any State or separate customs territory possessing full autonomy in the conduct of its external commercial relations and of the other matters provided for in this Agreement and the Multilateral Trade Agreements may accede to this Agreement, on terms to be agreed between it and the WTO. Such accession shall apply to this Agreement and the Multilateral Trade Agreements annexed thereto. (emphasis added)

130. The terms and conditions of the accession of the People's Republic of China to the

WTO Agreement are set out in the Protocol on the Accession of the People's

Republic of China (hereafter Accession Protocol).115

131. According to Part I, paragraph 1.2 of the Accession Protocol

The WTO Agreement to which China accedes shall be the WTO Agreement as rectified, amended or otherwise modified by such legal instruments as may have entered into force before the date of accession. This Protocol, which shall include the commitments referred to in paragraph 342 of the Working Party Report, shall be an integral part of the WTO Agreement. (emphasis added)

132. According to Part I, paragraph 7.3 of the Accession Protocol

115 Exhibit JE – 1.

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China shall, upon accession, comply with the TRIMs Agreement, without recourse to the provisions of Article 5 of the TRIMs Agreement. China shall eliminate and cease to enforce trade and foreign exchange balancing requirements, local content and export or performance requirements made effective through laws, regulations or other measures. Moreover, China will not enforce provisions of contracts imposing such requirements. Without prejudice to the relevant provisions of this Protocol, China shall ensure that the distribution of import licences, quotas, tariff-rate quotas, or any other means of approval for importation, the right of importation or investment by national and sub-national authorities, is not conditioned on: whether competing domestic suppliers of such products exist; or performance requirements of any kind, such as local content, offsets, the transfer of technology, export performance or the conduct of research and development in China. (emphasis added)

133. Paragraph 342 of the Working Party report116 identifies those paragraphs of the

Working Party Report that are incorporated in paragraph 1.2 of the Accession

Protocol. These include paragraph 203, according to which

The representative of China confirmed that upon accession, as set forth in the Draft Protocol, China would comply fully with the TRIMs Agreement, without recourse to Article 5 thereof, and would eliminate foreign-exchange balancing and trade balancing requirements, local content requirements and export performance requirements. Chinese authorities would not enforce the terms of contracts containing such requirements. The allocation, permission or rights for importation and investment would not be conditional upon performance requirements set by national or sub-national authorities, or subject to secondary conditions covering, for example, the conduct of research, the provision of offsets or other forms of industrial compensation including specified types or volumes of business opportunities, the use of local inputs or the transfer of technology. Permission to invest, import licences, quotas and tariff rate quotas would be granted without regard to the existence of competing Chinese domestic suppliers. Consistent with its obligations under the WTO Agreement and the Draft Protocol, the freedom of contract of enterprises would be respected by China. The Working Party took note of this commitment. (emphasis added)

(b) The Measures are inconsistent with the Accession Protocol

134. It has been demonstrated above that the Measures are inconsistent with the TRIMs

Agreement.

116 Exhibit JE – 26.

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135. One of the specific conditions of China's accession to the WTO under Article XII

of the WTO agreement was that China complies fully with the TRIMs Agreement,

and that it eliminates and ceases to enforce local content requirements made

effective through laws, regulations or other measures, upon accession.

136. As the European Communities has demonstrated above that the Measures are

inconsistent with the TRIMs Agreement and in particular with Article 2 thereof in

conjunction with paragraphs 1 (a) and 2 (a) of the Illustrative List annexed thereto,

it follows necessarily that the Measures are inconsistent with China's obligations

under the WTO Agreement, as set out in the Accession Protocol, in particular Part

I, paragraph 7.3 of the Accession Protocol, and paragraph 203 of the Working

Party Report on the Accession of China in conjunction with Part I, paragraph 1.2

of the Accession Protocol, and paragraph 342 of the Working Party Report on the

Accession of China.

C. The Measures are inconsistent with Article III of GATT 1994

1. Introduction

137. The European Communities considers that the Measures are inconsistent with

Article III, paragraphs 2, 4 and 5 of the GATT 1994.

138. Although China might present the Measures as aiming to enforce its tariff

schedules, a more detailed examination demonstrates that this is not true. Indeed,

the application of the Measures is triggered by the actual manufacturing process

taking place in China.

139. As explained more in detail above (see sections II D.3 to F.6 and G), whether

imported parts will be subject to the Measures (and the treatment that will

subsequently be applicable) depends on the use to which the parts are put in China.

The Measures apply to imported parts only if they are used "to produce

automobiles for sale on the domestic market" (Article 7 of Decree 125). Also, it is

only once the imported parts have been assembled and processed into a complete

vehicle that the internal charge is imposed if the domestic content is insufficient.

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140. If the processing and manufacturing of the products after importation into the

territory of a Member could be generally accepted as an intermediate step before

tariff classification, the whole system of tariff classification would lose its

meaning. Such a conclusion would compromise the object and purpose of the

WTO Agreement, generally, as well as of the GATT 1994 that is, "the security and

predictability of the reciprocal and mutually advantageous arrangements directed

to the substantial reduction of tariffs and other barriers to trade".117 Therefore, the

European Communities considers that in truth the Measures are internal measures.

2. The Measures are inconsistent with Article III:4 GATT 1994

(a) Introduction

141. According to Article III:4 GATT 1994, in relevant part

The products of the territory of any contracting party imported into the territory of any other contracting party 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.

142. On the basis of established case law, this provision sets out a three stage test for

assessing the consistency of measures there under. In Korea – Various Measures

on Beef, the Appellate Body considered as follows:

For a violation of Article III:4 to be established, three elements must be satisfied: that the imported and domestic products at issue are "like products"; that the measure at issue is a "law, regulation, or requirement affecting their internal sale, offering for sale, purchase, transportation, distribution, or use"; and that the imported products are accorded "less favourable" treatment than that accorded to like domestic products.118

143. Article III:1 sets out the context of Article III:4. Although the Appellate Body has

considered that a determination of whether there has been a violation of Article

III:4 does not require a separate consideration of whether a measure "afford[s]

117 Appellate Body Report, EC- Chicken cuts, at para 243. 118 Appellate Body Report, Korea – Various Measures on Beef, at para. 133.

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protection to domestic production" it lays down the general principle pursued by

that provision.119

144. In the following sections the European Communities will demonstrate that the

Measures are inconsistent with Article III:4 of the GATT 1994. This will be done

following the three staged test established by the Appellate Body in Korea –

Various Measures on Beef. It will thus be demonstrated that all the three elements

are fulfilled i.e. the imported and domestic automobile parts are "like products";

the Measures constitute "laws, regulations or requirements affecting the internal

sale, offering for sale, purchase, transportation, distribution, or use" of the

imported like products and that the imported automobile parts and components are

accorded "less favourable" treatment than that accorded to like domestic products.

(b) The products are "like"

145. In EC – Asbestos, the Appellate Body provided a general framework under which

the likeness of particular products could be examined although it also emphasised

the need to take all pertinent evidence into account in the determination whether

products are "like".120 However, in the present case the Measures themselves treat

the domestic and imported parts and components as "like". The only distinction is

made on the basis of the origin of the products. Their properties, nature and quality

are deemed identical. As considered by the Panel e.g. in India- Autos, the mere

origin of the good cannot make an imported good "unlike" the domestic good.121

146. Consequently, for the purposes of Article III:4, the products in question are "like".

(c) The measures at issue are laws, regulations, or requirements affecting the internal sale, offering for sale, purchase, transportation, distribution, or use of the imported products

147. The Measures are generally applicable laws and regulations. There is no doubt that

all automobile manufacturers that use imported parts for the assembly and

119 Appellate Body Report, EC – Bananas III, at para 216, Appellate Body Report, EC – Asbestos, at

para 93. 120 Appellate Body Report, EC – Asbestos, at para 101.

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manufacture of vehicles are obliged to comply with the Measures and that the

Measures influence the decision-making of the automobile manufacturers.122 The

analysis will therefore concentrate on how the Measures affect the internal sale,

offering for sale, purchase, transportation, distribution, or use of the imported

automotive parts.

148. The interpretation of the criterion of "affecting the internal sale etc." is well

established. In GATT case US – Section 337, the panel first referred back to an

early GATT panel report in Italy – Agricultural Machinery that had emphasised

that "the drafters of the Article intended to cover in paragraph 4 not only laws and

regulations, which directly governed the conditions of sale and purchase but also

any laws or regulations which might adversely modify the conditions of

competition between the domestic and imported products on the internal

market".123 Then the panel in US – Section 337 considered that

"…enforcement procedures cannot be separated from the substantive provisions they serve to enforce. If the procedural provisions of internal law were not covered by Article III:4, contracting parties could escape the national treatment standard by enforcing substantive law … through procedures less favourable to imported products than to like products of national origin."124 (emphasis added)

149. The Measures apply only if automotive parts are imported. As described in detail

above (see section F), they impose very strict procedural and administrative rules

on imported parts for the purposes of verifying if they are "Deemed Whole

Vehicles". Only if a vehicle is 100 % "made in China" the manufacturer and the

parts it uses will never be subject to the procedural constraints of the Measures.

150. As described in greater detail under background section II E and the analysis under

the TRIMs Agreement (see section III B), sufficient local content must be ensured

in order to escape the internal charge of 15 % if imported parts are used in the

manufacture of vehicles.

121 Panel Report, India – Autos, at para. 7.174. 122 See e.g. Panel Report, India – Autos, at para. 7.192. 123 GATT Panel Report, Italy – Agricultural Machinery, at para. 12. 124 GATT Panel Report, US – Section 337, at para. 5.10.

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151. As described above (see paras. 137-140), many elements thereof apply after the

parts are already used in production and complete vehicles have been made out of

them. In the view of the European Communities, one can only conclude that such

procedures are bound to adversely modify the conditions of competition between

the domestic and imported products on the internal market.

(d) Treatment no less favourable

152. This criterion was examined in clear terms by the panel in GATT case US –

Section 337, where it interpreted "treatment no less favourable" as requiring

"effective equality of competitive opportunities".125 This test has later been

confirmed by the Appellate Body. For instance, in Korea – Various Measures on

Beef the Appellate Body stated that

A formal difference in treatment between imported and like domestic products is thus neither necessary, nor sufficient, to show a violation of Article III:4. Whether or not imported products are treated "less favourably" than like domestic products should be assessed instead by examining whether a measure modifies the conditions of competition in the relevant market to the detriment of imported products.126

153. The European Communities is of the view that the Measures fundamentally

modify the conditions of competition in the Chinese market to the detriment of

imported automotive parts.

154. First, only imported parts may be subject to the additional internal charge.

155. Second, as demonstrated above the use of imported parts will oblige the

automobile manufacturers to comply with very stringent administrative procedures

of registration and verification of the "status" of the parts under the Chinese

legislation. These Measures not only considerably complicate the start of the

manufacturing process, but they also take away most if not all flexibility the

manufacturer has for the development of the vehicle model including any

logistical changes the manufacturer might wish to make to its supplies. The

125 GATT Panel Report, US – Section 337,at para 5.11. 126 Appellate Body Report, Korea – Various Measures on Beef, at para 137.

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Measures also act as a considerable obstacle for offering any options on the basic

model of the vehicle if imported parts are used.

156. Therefore, and as demonstrated above under the section on the TRIMs Agreement,

(see section III B), the Measures discriminate against imported parts since

• only imported parts may become subject to the 15 % internal charge; and • only imported parts are subject to additional procedural requirements.

157. This affects drastically the conditions of competition of the imported parts. Indeed,

the investment decision of a company to enter the Chinese market is often, if not

even always, made conditional on making sure that the additional charge will not

be applied. The only way to achieve this result is to use Chinese made parts in

sufficient number, amount and/or combination. To use the words (mutatis

mutandis) of the Panel in India – Autos,

car manufacturers are thus not free to choose to purchase imported parts and components over domestic parts and components in excess of a certain proportion. In these circumstances, imported products cannot compete on an equal footing with Chinese-origin parts and components because the indigenization requirement explicitly sets out the percentage of domestic parts and components that must be used in order to obtain the advantages that complying with the local content rules entail. Such requirements clearly modify the conditions of competition of domestic and imported parts and components in the Chinese market in favour of domestic products.127

158. The European Communities is of the view that by imposing these Measures on

manufacturers that use imported parts, China has failed to accord, to products of

the territory of the European Communities imported into the territory of China,

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. Consequently, the

Measures are inconsistent with Article III:4 of the GATT 1994.

127 See Panel report, India – Autos, at para 7.201 -7.202.

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3. The Measures are inconsistent with Article III:2 of the GATT 1994

159. According to Article III:2,

The products of the territory of any contracting party imported into the territory of any other contracting party 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. Moreover, no contracting party shall otherwise apply internal taxes or other internal charges to imported or domestic products in a manner contrary to the principles set forth in paragraph 1.

160. The European Communities will demonstrate in the following that the Measures

violate Article III:2, first sentence or, in the alternative, Article III:2, second

sentence.

(a) Article III:2, first sentence of the GATT 1994

161. The Appellate Body in Japan – Alcoholic Beverages II spelled out a two-pronged

test for assessing the consistency of measures with Article III:2, first sentence:

Read in their context and in the light of the overall object and purpose of the WTO Agreement, the words of the first sentence require an examination of the conformity of an internal tax measure with Article III by determining, first, whether the taxed imported and domestic products are "like" and, second, whether the taxes applied to the imported products are "in excess of" those applied to the like domestic products. If the imported and domestic products are "like products", and if the taxes applied to the imported products are "in excess of" those applied to the like domestic products, then the measure is inconsistent with Article III:2, first sentence.128

162. As the first sentence of Article III:2 does not specifically invoke Article III:1, the

presence of a protective application within the meaning of Article III:1 need not be

established separately from these two specific requirements included in the first

sentence.129

163. The European Communities will demonstrate below that the Measures are

inconsistent with the first sentence of Article III:2 because imported and domestic

128 Appellate Body report in Japan – Alcoholic Beverages II, p. 18 – 19. 129 Appellate Body report in Japan – Alcoholic Beverages II, p. 18.

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auto parts are "like products" and internal charges applied to imported auto parts

are "in excess of" those applied to the like domestic products.

i) The products are "like"

164. As demonstrated above with regard to the determination of "like products" in

Article III:4 (see paras. 145-146), there is no need to compare actually traded

products since the only distinction made in the Measures is on the basis of the

origin of the auto parts.

165. The same considerations apply for Article III:2. The Panel in Indonesia – Autos set

out that there can be circumstances under which the determination of whether

imported and domestic products are "like" within the meaning of Article III:2 does

not require an examination of the characteristics of actually traded products. This

is the case where

[t]he distinction between the products, which results in different levels of taxation, is not based on the products per se, but rather on such factors as the nationality of the producer or the origin of the parts and components contained in the product. As such, an imported product identical in all respects to a domestic product, except for its origin or the origin of its parts and components or other factors not related to the product itself, would be subject to a different level of taxation. (…) In our view, such an origin-based distinction in respect of internal taxes suffices in itself to violate Article III:2, without the need to demonstrate the existence of actually traded like products.130

166. The Measures only apply to imported, and not to domestic auto parts. Imported

auto parts identical in all respects to domestic auto parts, except for their origin,

will – depending on the amount of local content in the assembled vehicle – be

subject to internal charges. Domestic auto parts, identical in all respects to the

imported ones except for their origin, do not fall under the Measures.

167. Consequently, imported and domestic auto parts are to be considered as "like

products" within the meaning of Article III:2, first sentence.

130 Panel in Indonesia – Autos, at paras 14.112 and 14.113.

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ii) The internal charges applied to imported products are "in excess of" those applied to like domestic products

168. According to the Appellate Body in Japan – Alcoholic Beverages II, subjecting

imported products to "even the smallest amount of 'excess' [in charges] is too

much" since the "in excess of" requirement is not conditional on a trade effects test

nor qualified by a de minimis standard.131

169. As described in greater detail above (see paras. 57-58), imported auto parts will

be, pursuant to Article 28 of Decree 125, subject to internal charges if they are

assembled into vehicles and qualify as Deemed Whole Vehicles because they meet

one of the three tests set out in Article 21 of Decree 125. These internal charges

typically amount to 15%. Domestic auto parts, identical in all respects to the

imported ones except for their origin, cannot be subject to such internal charges.

170. Therefore, charges applied to imported auto parts are necessarily "in excess of" the

charges applied to like domestic products.

iii) Conclusion

171. The Measures are inconsistent with the first sentence of Article III:2 because they

impose internal charges on imported auto parts in excess of those imposed on like

domestic products.

(b) Article III:2, second sentence of the GATT 1994

172. Should the Panel not find a violation of the first sentence of Article III:2, the

European Communities will, in the alternative, demonstrate below that the

Measures are inconsistent with Article III:2, second sentence which provides:

Moreover, no contracting party shall otherwise apply internal taxes or other internal charges to imported or domestic products in a manner contrary to the principles set forth in paragraph 1.

173. Article III:2, second sentence specifically invokes Article III:1 which states in

relevant part:

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The contracting parties recognize that internal taxes and other internal charges, (…), should not be applied to imported or domestic products so as to afford protection to domestic production.

174. Article III:2, second sentence, is accompanied by an Ad Article which clarifies:

A tax conforming to the requirements of the first sentence of paragraph 2 would be considered to be inconsistent with the provisions of the second sentence only in cases where competition was involved between, on the one hand, the taxed product and, on the other hand, a directly competitive or substitutable product which was not similarly taxed.

175. The Appellate Body in Japan – Alcoholic Beverages II held that Article III:2,

second sentence, and the accompanying Ad Article have equivalent legal status

because they were negotiated and agreed at the same time. Consequently, they

must be read together which yields the following three-pronged test:

Giving full meaning to the text and to its context, three separate issues must be addressed to determine whether an internal tax measure is inconsistent with Article III:2, second sentence. These three issues are whether: (1) the imported products and the domestic products are "directly competitive or substitutable products" which are in competition with each other; (2) the directly competitive or substitutable imported and domestic products are "not similarly taxed"; and (3) the dissimilar taxation of the directly competitive or substitutable imported domestic products is "applied ... so as to afford protection to domestic production".132

176. The European Communities will demonstrate below that the Measures fulfil all

three elements of Article III:2, second sentence.

i) The imported and the domestic products are "directly competitive or substitutable"

177. The Appellate Body in Japan – Alcoholic Beverages II held that the category of

"directly competitive or substitutable products" in Article III:2, second sentence is

broader than that of "like products" in the first sentence. The question whether

products are "directly competitive or substitutable" needs to be determined on a

case-by-case basis applying factors such as their physical characteristics, common

131 Appellate Body Report in Japan – Alcoholic Beverages II, p. 23.

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end-uses, tariff classifications, or actual examples of substitution in the relevant

markets.133

178. In the present case, however, there is no need to apply these factors to actually

traded products. As demonstrated above, the Measures discriminate between auto

parts on the basis of their origin as either imported or domestic. Any imported auto

part identical in all respects to a domestic auto part, except for its origin, will –

depending on the amount of local content in the assembled vehicle – be subject to

a different level of internal charges.

179. Imported and domestic automobile parts that are identical in all respects, except

for their origin, are necessarily "directly competitive or substitutable".

ii) The directly competitive or substitutable imported and domestic products are "not similarly taxed"

180. According to the Appellate Body in Japan – Alcoholic Beverages II, imported and

domestic products are "not similarly taxed" if the tax burden on imported products

is heavier than on "directly competitive or substitutable" domestic products and

that burden is more than de minimis in any given case.134

181. It was established above that the Measures provide for the imposition of internal

charges on imported, but not on domestic auto parts. Therefore, the burden of

internal charges on imported products is necessarily heavier than on directly

competitive and substitutable domestic products.

182. The differential is also more than de minimis. Whether any particular differential

amount of taxation is de minimis or not must be determined on a case-by-case

basis.135 As set out in further detail above (see paras. 57-58), the internal charges

imposed on imported auto parts that are assembled into vehicles and qualify as

Deemed Whole Vehicles pursuant to Article 21 of Decree 125 typically amount to

15%. Domestic auto parts, which are directly competitive or substitutable, are not

132 Appellate Body Report in Japan – Alcoholic Beverages II, p. 24. 133 Appellate Body Report in Japan – Alcoholic Beverages II, p. 25. 134 Appellate Body Report in Japan – Alcoholic Beverages II, p. 27. 135 Appellate Body Report in Japan – Alcoholic Beverages II, p. 27.

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charged under Article 28 of Decree 125. Such a difference in the level of charges

is clearly more than de minimis. Therefore, imported and domestic auto parts are

"not similarly taxed".

iii) The dissimilar taxation of the directly competitive or substitutable imported domestic products is "applied ... so as to afford protection to domestic production"

183. In Japan – Alcoholic Beverages II, the Appellate Body stated that protective

application of a measure can "be discerned from the design, the architecture, and

the revealing structure of a measure" and may also be evidenced by the "very

magnitude of the dissimilar taxation".136 The Panel in Indonesia – Autos concluded

that "the nature of the discrimination, which is to promote a national industry by

giving it advantages vis-à-vis imported products, is clearly designed so as to afford

protection to domestic production".137

184. These factors indicate protective application of the Measures in the present case.

First, the differential in charges between imported and directly competitive or

substitutable domestic products is so much above a de minimis level that this in

itself indicates that it is applied "so as to afford protection". Secondly, the

protective application follows from the very structure of the Measures which is

discrimination in order to promote a national industry by giving it advantages vis-

à-vis imported products. Thirdly, the protective application is even reflected in the

stated goals of the Measures which reveal the intent of the Chinese legislator to

protect domestic production.138

iv) Conclusion

185. It has been established that the Measures are inconsistent with the second sentence

of Article III:2 since they impose dissimilar charges on imported automobile parts

136 Appellate Body Report in Japan – Alcoholic Beverages II, p. 27-29. 137 Panel Report in Indonesia – Autos, at para 14.115. 138 See Article 3 of the Automotive Policy Order ("In 2010 vehicle manufacturers shall have forged a

number of well-known brands in automobile, motorcycle and parts products.") JE-18 and Article 1 of Decree 125 ("The measures are formulated pursuant to the relevant laws and regulations in order to

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and their directly competitive or substitutable domestic products and are, thus,

applied so as to afford protection to domestic production.

4. The Measures are inconsistent with Article III:5 of the GATT 1994

186. Article III:5 provides:

No contracting party shall establish or maintain any internal quantitative regulation relating to the mixture, processing or use of products in specified amounts or proportions which requires, directly or indirectly, that any specified amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources. Moreover, no contracting party shall otherwise apply internal quantitative regulations in a manner contrary to the principles set forth in paragraph 1.

187. The European Communities will demonstrate in the following that the Measures

violate Article III:5, first sentence or, in the alternative, Article III:5, second

sentence.

(a) Article III:5, first sentence of GATT 1994

188. Article III:5, first sentence contains three elements. The first element is the

existence of an "internal … regulation". Secondly, the internal regulation must be

"quantitative" in that it is "relating to the mixture, processing or use of products in

specified amounts or proportions". Thirdly, it needs to be established that such a

regulation "requires, directly or indirectly, that any specified amount or proportion

of any product which is the subject of the regulation must be supplied from

domestic sources".

189. As the first sentence of Article III:5 does not specifically invoke Article III:1, the

interpretative principles developed by the Appellate Body in Japan – Alcoholic

Beverages II with regard to Article III:2139 support that a protective application

within the meaning of Article III:1 need not be established separately from the

three specific elements included in the first sentence of Article III:5.

standardize and strengthen the import administration of automotive parts and to stimulate the sound development of the automotive industry.") Exhibit JE – 27.

139 Appellate Body report in Japan – Alcoholic Beverages II, p. 18.

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190. The European Communities will demonstrate below that the Measures fulfil all

three elements of Article III:5, first sentence.

i) The Measures are an "internal … regulation"

191. The Measures constitute a "regulation" within the meaning of Article III:5, first

sentence. The term "regulation" refers to "[a] rule prescribed for controlling some

matter, or for the regulating of conduct; an authoritative direction, a standing

rule".140 Its context in Article III:5 ("[n]o contracting party shall establish or

maintain any … regulation …") indicates that it must originate from the authorities

of a WTO Member. The Measures constitute authoritative rules controlling the

administrative and fiscal treatment of imported auto parts and they all originate

from Chinese authorities. The Automotive Policy Order was adopted by the

National Development and Reform Commission. Decree 125 was promulgated by

the General Administration of Customs, the National Development and Reform

Commission, the Ministry of Finance and the Ministry of Commerce.

Announcement 4 was formulated by the General Administration of Customs.

ii) The Measures are "quantitative … relating to the mixture, processing or use of products in specified amounts or proportions"

192. The term "quantitative" means "[p]ertaining to or concerned with quantity or its

measurement" while "quantity" refers to "the portion, amount, or number (of

something) present in a particular instance".141 The requirement "relating to the

mixture, processing and use of products in specified amounts or proportions"

narrows down the group of all possible quantitative regulations to those that

concern the quantity of products when they are mixed, processed or used.

193. The Measures are "quantitative" because they are concerned with the amounts and

portions of domestic or imported auto parts in assembled vehicles and their

assemblies. As auto parts are "products" which are processed and used during the

140 Exhibit JE – 34. 141 Exhibit JE – 34..

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assembly of vehicles, the Measures also relate to the "mixture, processing or use of

products".

194. This follows from Article 21 of Decree 125 which sets out maximum amounts and

proportions of imported auto parts which must not be surpassed when using them

in the assembly of vehicles. Otherwise, the imported auto parts are classified

"Deemed Whole Vehicles". The thresholds in Article 21(2) explicitly refer to

certain amounts of imported assemblies in the vehicle. The threshold in Article

21(3) is based on the proportion of imported parts in the aggregate price of the

vehicle. Article 22 of Decree 125 contains similar quantitative criteria for the use

of imported auto parts in the manufacturing of assemblies and even explicitly

characterises them as "quantity criteria" (in Article 22(2) of Decree 125). If not

respected, these quantity criteria will lead to treat the manufactured assembly as

imported, which may, in turn, lead to imported parts being qualified as Deemed

Whole Vehicles by application of Article 21(2) of Decree 125.

195. It is worth noting that the panel in US – Tobacco characterised the US Domestic

Marketing Assessment (DMA) legislation as a "quantitative" regulation "relating

to the use of a product" because "it set a minimum specified proportion of 75 per

cent for the use of U.S. tobacco in manufacturing cigarettes".142 The Chinese

Measures are very similar to the DMA legislation but for the fact that they relate to

auto parts and vehicle manufacturing instead of tobacco and cigarettes.

iii) The Measures "requir[e], directly or indirectly, that any specified amount or proportion of any product which is the subject of the regulation must be supplied from domestic sources"

196. The Measures also fulfil the third element of Article III:5, first sentence. They

require that specified amounts or proportions of auto parts used in the assembly of

vehicles are not imported and instead of domestic origin. Vehicle manufacturers

have to obtain domestic parts if they want to remain within the thresholds for

maximum amounts or proportions of imported parts set out in Articles 21 and 22

of Decree 125. For example, if they import the engine assembly, they will have to

142 GATT Panel Report in US – Tobacco, at para 67.

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use a vehicle body which is not imported or Deemed Imported under Article 22 of

Decree 125, in order to ensure that the vehicle does not contain two imported main

Assemblies (see Article 21(2)(a) of Decree 125). Otherwise, all imported parts

assembled in that vehicle are categorized "Deemed Whole Vehicles" and charged

according to the duty rate for complete vehicles pursuant to Article 28 of Decree

125.

197. The term "requires" in Article III:5, first sentence encompasses situations like in

the present case in which non-compliance with the quantitative local content

provision is not outright prohibited but entails negative financial consequences.

Such an interpretation is, firstly, indicated by the term "indirectly" in Article III:5,

first sentence. Secondly, Article III:5, first sentence would be deprived of any

useful effect if WTO Members were free to enforce their quantitative local content

provisions through the imposition of financial disadvantages. Thirdly, such an

interpretation is supported by the Panel Report in US – Tobacco. The Panel found

that the DMA "required" cigarettes manufacturers to use at least 75% domestic

tobacco because they were otherwise obliged to pay to the US Department of

Agriculture a non-refundable marketing assessment (i.e. an amount based on the

price difference between domestic and imported tobacco) and to purchase certain

amounts of domestic tobacco.143 These are negative financial consequences

comparable to the internal charges which vehicle manufacturers in China face if

they do not comply with the local content provisions of Articles 21 and 22 of

Decree 125.

iv) Conclusion

198. As demonstrated above, the Measures constitute "internal quantitative regulation

relating to the (…) use of products in specified amounts or proportions" and also

"requir[e], directly or indirectly, that any specified amount or proportion of any

product which is the subject of the regulation must be supplied from domestic

sources". Therefore, they are inconsistent with Article III:5, first sentence.

143 GATT Panel Report in US – Tobacco, at para 68.

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(b) Article III:5, second sentence of GATT 1994

199. Should the Panel not find a violation of the first sentence of Article III:5, the

European Communities will, in the alternative, demonstrate below that the

Measures are inconsistent with Article III:5, second sentence.

200. Article III:5, second sentence provides:

Moreover, no contracting party shall otherwise apply internal quantitative regulations in a manner contrary to the principles set forth in paragraph 1.

201. Article III:5, second sentence refers to Article III:1 which states in relevant part:

The contracting parties recognize that (…) internal quantitative regulations requiring the mixture, processing or use of products in specified amounts or proportions, should not be applied to imported or domestic products so as to afford protection to domestic production.

202. It has been established above that the Measures constitute "internal quantitative

regulations requiring the mixture, processing or use of products in specified

amounts or proportions".

203. China applies the Measures "so as to afford protection to domestic production". It

was demonstrated above in the context of Article III:2, second sentence, that

China imposes internal charges "so as to afford protection" because, firstly, the

imposed differential in charges was significantly above a de minimis level,

secondly because of the very structure of the Measures which discriminate only on

the basis of the origin of products and, thirdly, for the fact that protectionist intent

is reflected in the stated goals of the Measures. These considerations also apply in

the assessment of the Measures under Article III:5, second sentence and lead to the

conclusion that the Measures are inconsistent with Article III:5, second sentence.

5. The Measures are inconsistent with the WTO Agreement, as set out in the Protocol of Accession of the People's Republic of China to the WTO, in particular Part I, paragraph 7.2 of the protocol of Accession of China

204. The terms of accession of China to the WTO have been examined generally above

under section B.3. In addition to the inconsistency under Part I, paragraph 7.3 of

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the Accession Protocol established above, the European Communities considers

that the Measures are also inconsistent with Part I, paragraph 7.2 of the Accession

Protocol, which states as follows:

In implementing the provisions of Articles III and XI of the GATT 1994 and the Agreement on Agriculture, China shall eliminate and shall not introduce, re-introduce or apply non-tariff measures that cannot be justified under the provisions of the WTO Agreement. For all non-tariff measures, whether or not referred to in Annex 3, that are applied after the date of accession, consistent with the WTO Agreement or this Protocol, China shall allocate and otherwise administer such measures in strict conformity with the provisions of the WTO Agreement, including GATT 1994 and Article XIII thereof, and the Agreement on Import Licensing Procedures, including notification requirements. (emphasis added)

205. As demonstrated above, the Measures are inconsistent with Article III, paragraphs

2, 4 and 5 of the GATT 1994. By adopting the Measures China has introduced non-

tariff measures that cannot be justified under the provisions of the WTO

Agreement. Clearly, China cannot implement Article III of the GATT by

introducing measures that are inconsistent with that provision without violating the

commitments it has taken under the terms of its accession to the WTO.

206. Consequently, China has acted inconsistently with its obligations under the WTO

Agreement as set out in its Accession Protocol, in particular Part I, paragraph 7.2

of the Accession Protocol.

D. Alternatively: The Measures are inconsistent with Article II:1 (a) and (b) of the GATT 1994

1. Introduction

207. As is clear from the foregoing considerations, the European Communities is of the

view that the Measures are inconsistent with the TRIMs Agreement and Article III,

paragraphs 2, 4 and 5 of the GATT 1994, together with various specific

commitments taken by China in relation to these agreements in its Accession

Protocol to the WTO. Consequently, the European Communities considers that

there is no need to address whether the Measures would be inconsistent with

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Article II of the GATT 1994 and advances this claim only for the case that the

Panel dismisses the claims under the TRIMs Agrement and Article III GATT 1994.

208. Therefore, should the Panel not agree that the Measures consist of internal

measures (quod non), the European Communities will demonstrate that the

Measures are inconsistent with Article II:1 (a) and (b) of the GATT 1994.

209. Article II:1 (a) and (b) GATT state respectively as follows:

(a) Each contracting party shall accord to the commerce of the other contracting parties treatment no less favourable than that provided for in the appropriate Part of the appropriate Schedule annexed to this Agreement.

(b) The products described in Part I of the Schedule relating to any contracting party, which are the products of territories of other contracting parties, shall, on their importation into the territory to which the Schedule relates, and subject to the terms, conditions or qualifications set forth in that Schedule, be exempt from ordinary customs duties in excess of those set forth and provided therein. Such products shall also be exempt from all other duties or charges of any kind imposed on or in connection with the importation in excess of those imposed on the date of this Agreement or those directly and mandatorily required to be imposed thereafter by legislation in force in the importing territory on that date.

210. Measures that provide treatment less favourable to the commerce of other

contracting parties than the treatment afforded in the appropriate Schedule and that

impose duties in excess of what is provided for in the appropriate Schedule are

inconsistent with Articles II:1(a) and II:1(b) of the GATT 1994.

211. Article II:1(a) contains a general prohibition against according treatment less

favourable to imports than that provided for in a Member's Schedule. Under the

first sentence of paragraph (b) of Article II:1, the essential obligation is that

ordinary customs duties must not be applied in excess of the bound rates provided

for in a Member's Schedule.

212. It will be demonstrated below that China has failed to accord to the commerce of

the European Communities treatment no less favourable than that provided for in

the appropriate Part of the appropriate Schedule annexed to the GATT. China has

failed to exempt products, which are the products of territories of the European

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Communities on their importation into China's territory, from ordinary customs

duties in excess of those set forth and provided in China's Schedule144.

213. In the alternative, China has failed to exempt such products from all other duties or

charges of any kind imposed on or in connection with the importation in excess of

those imposed on the date of China becoming a Member and bound by the

provision or those directly and mandatorily required to be imposed thereafter by

legislation in force in the importing territory on that date. In other words, even if

the Panel were to find that the additional charge is not properly classified as an

ordinary custom duty, it must necessarily be classified as "other duties or charges"

under the second sentence of Article II:1(b).

2. Description of the Chinese tariff schedule and the relevant bound rates of duty

(a) General considerations

214. China is party to the International Convention on the Harmonized Commodity

Description and Coding System, done at Brussels on 14 June 1983 (the term

Harmonized System is generally abbreviated to HS)145. The HS Convention

entered into force on 1 January 1988. More than 170 countries and customs or

economic unions use the HS nomenclature as the basis for their customs tariffs and

for the collection of international trade statistics.

215. Even if Article 9 of the HS Convention states that "[t]he Contracting Parties do not

assume by this Convention any obligation in relation to rates of Customs duty", it

is nevertheless a fact that tariff negotiations and the results thereof are related to

specific headings in the HS nomenclature. Even if each WTO member has its own

individual Schedule of tariff concessions and the tariff commitments bound for

specific products in those Schedules vary between different WTO Members, the

Appellate Body has stated that “[n]onetheless, it must be borne in mind that,

144 Exhibit JE – 2. 145 Exhibit JE – 35.

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during the course of the Uruguay Round, tariff commitments were negotiated on

the basis of the Harmonized System”.146

216. The annex to the Convention comprises the rules for the interpretation of the

Harmonized System (General Rules for the Interpretation of the Harmonized

System - GIR) 147 and the HS nomenclature itself. The titles of Sections, Chapters

and sub-chapters are provided for ease of reference only. What matters in

identifying the correct classification in the nomenclature is the terms of the

headings (of which there are 1221 4-digit codes) and the subheadings (of which

there are 5052 6-digit codes) as well as associated section and chapter notes. To

assist in the task of classification, HS Explanatory Notes have been created. There

are specific rules in the form of Section and Chapter notes which assist in

determining if a product is a part or an accessory or classified as a product in its

own right.

217. It is of paramount importance to underline that when goods are classified in the HS

nomenclature, it is always done on the basis of the objective characteristics of the

product at the time of importation.

218. Chapter 87 of the HS nomenclature and therefore of China's nomenclature is

entitled "Vehicles other than railway or tramway rolling-stock, and parts and

accessories thereof". The products covered by the Measures under dispute mainly

fall within chapter 87, as described below.

(b) Complete vehicles

219. Headings 87.01 to 87.05148 cover the following complete vehicles:

- 87.01 Tractors (other than tractors of heading No. 87.09)

- 87.02 Motor Vehicles for the transport of ten or more persons, including the driver

146 Appellate Body in EC- Customs Classification of Frozen Boneless Chicken Cuts, at para. 262. 147 Appellate Body in EC- Customs Classification of Frozen Boneless Chicken Cuts, at para 233.

General Rules are, by their very nature, rules for interpretation of the Harmonized System. 148 Exhibit JE-2.

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- 87.03 Motor Cars and other motor vehicles principally designed for the transport of persons (other than those of heading No 8702), including station wagons and racing cars

- 87.04 Motor Vehicles for the transport of goods

- 87.05 Special purpose motor vehicles, other than those principally designed for the transport of persons or goods (for example, breakdown lorries, crane lorries, fire fighting vehicles, concrete-mixer lorries, road sweeper lorries, spraying lorries etc.)

220. These headings for complete vehicles are then divided into subheadings, both at

the 6 digit HS subheading level and at the 8 digit level in the Chinese tariff

schedule, on the basis of different criteria such as the use of the vehicle, the size of

the vehicle, the type of the engine and the size of the engine.

221. The final bound rate of the Chinese tariff schedule varies, depending on the

specific type of vehicle, between

- 6 and 9 % under heading 87.01 (tractors)

- 6 and 25 % under heading 87.04 (motor vehicles for the transport of goods)

and

- between 3 and 15 % under heading 87.05 (special purpose vehicles).

222. However, with one exception (buses for transport of passengers at airport subject

to a final bound duty rate of 4%), the final bound rate of duty is 25 % for vehicles

of

- heading 87.02 (motor vehicles for the transport of ten or more persons, including the driver and

- heading 87.03 (motor cars and other motor vehicles principally designed for the transport of persons (other than those of heading 8702), including station wagons and racing cars).

223. The vehicles that fall under the Measures subject to this dispute are "motor

vehicles having at least 4 wheels and used for carrying passengers" and "motor

vehicles having at least 4 wheels and used for carrying freight", pursuant to Article

3 of decree 125. These vehicles fall under headings 87.02, 87.03 and 87.04.

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224. These three headings consist of 49 subheadings denoting different types of

vehicles. Of these 49 types of vehicles all but one of the types falling under

heading 87.02 (six out of seven "buses"), all falling under 87.03 (32 out of 32

"cars") and two falling under 87.04 (two out of ten "lorries") are subject to a final

bound rate of duty of 25 %. The final bound rate of duty for the remaining vehicles

varies between 4 % (subheading 8702.1020 for buses for transport of passengers at

airport) and 20 % (various lorries under heading 87.04).

225. Hence, most (40 out of 49) of the complete vehicles that fall within the scope of

the Measures are subject to a final bound rate of duty of 25 %.

(c) Intermediate products

226. Headings 87.06 and 87.07149 comprise of "intermediate products", that is, products

which are neither complete motor vehicles nor parts and accessories thereof.

227. Heading 87.06 covers

- chassis fitted with engines, for the motor vehicles of headings Nos. 87.01 to 87.05.

228. In other words, heading 87.06 describes products which combine the chassis (and

the parts that make up the chassis) with an engine (and the parts that make up the

engine). Other parts can be also be fitted on without the product falling outside the

heading. Indeed, products falling under heading 87.06 are "motor vehicles without

bodies"150. The final bound rate of duty in the Chinese tariff schedule under

heading 87.06 varies between 8 and 20 % depending on the type of the vehicle for

which the chassis and the engine is imported prior to manufacturing, assembly and

other processing. With one exception (chassis fitted with engine for manufacturing

of a bus of 30 seats or more) imports of such chassis fitted with engine are subject

to a final bound rate of duty between 8 and 10 %.

229. Similarly, heading 87.07 entitled "bodies (including cabs) for the motor vehicles of

headings Nos. 87.01 to 87.05" consists of complete bodies (including cabs) for the

149 Exhibit JE-2. 150 HS Explanatory Notes on chapter 87. Exhibit JE – 37.

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different types of motor vehicles and all the parts that make up the body. In all

cases, bodies are subject to a final bound rate of duty in the Chinese tariff schedule

of 10 %.

230. Consequently, most of the "intermediate products" covered by the Measures are

subject to a duty of 10%.

(d) Parts

231. Heading 87.08 is entitled "parts and accessories of the motor vehicles of headings

Nos. 87.01 to 87.05"151. This heading consists of the different parts and

accessories that make up the complete vehicles of Headings 87.01 to 87.05 with a

few exceptions, such as engines and parts thereof (HS headings 84.07, 84.08,

84.09, 85.01 and 85.03) and accumulators and parts thereof (85.06 and 85.07).152

232. The final bound rate of duty in the Chinese tariff schedule of the different types of

parts and accessories under heading 87.08 varies between 6 and 25 %. However,

in the overwhelming majority of cases for products to be used in vehicles under

headings 87.02 (vehicles for transport of more than 10 persons - buses), 87.03

(vehicles for transport of persons - cars) and 87.04 (vehicles for transport of goods

- lorries), which fall within the scope of the Measures, the final bound rates of duty

of parts and accessories are 10 % or less.

233. For those motor vehicle parts which do not fall under Chapter 87 the final bound

rate of duty in the Chinese tariff schedule (tyres, engines, accumulators and parts

thereof) varies generally between 2 and 10 %.

234. Although it artificially minimises the impact of the Measures, the figure of 10 % is

used in the following analysis as the typical bound rate of duty for vehicle parts.

However, the analysis should be read bearing in mind that in the case of many

parts and accessories, the bound rate of duty is much lower than 10 %.

151 Exhibit JE-2. 152 Ibid.

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(e) Conclusion

235. To sum up the structure of the nomenclature of the Chinese tariff schedule, there

are four different general categories of automotive products relevant for this case,

namely

1) complete vehicles (headings 87.01 to 87.05 of which headings 87.02 to 87.04 are most relevant in view of the scope of the Measures; 2) intermediate products such as the body and the chassis with engine (a combination of vehicle elements and/or parts fitted and/or equipped together without being complete vehicles (headings 87.06, 87.07) 3) parts and accessories of Chapter 87 (heading 87.08). 4) parts and accessories of motor vehicles classified elsewhere than Chapter 87 (tyres, engines, accumulators).

236. The difference between the bound rate of duty in the Chinese tariff schedule for

category 1 as compared with category 2, 3 and 4 is fundamentally important:

complete vehicles are generally subject to a duty of 25 % whereas intermediate

products under point 2, and parts and accessories under points 3 and 4 are

generally subject to a bound rate of duty of 10 % or less.

3. The inconsistency of the Measures with Chinese tariff commitments and Article II GATT 1994

(a) Preliminary considerations

237. As is clear from the analysis above the European Communities considers that in

reality these measures are internal measures subject to the scrutiny under the

TRIMs Agreement and Article III of the GATT 1994 and not measures for

enforcing the Chinese tariff schedules.

238. However, for the purposes of an analysis under Article II of the GATT 1994, we

must ignore many of these fundamental considerations and assume that the

Measures are to be examined from the point of view of tariff classification. The

European Communities will demonstrate in the following that even if Article II of

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the GATT would be applicable (quod non), the Measures are inconsistent with that

provision.

239. The established standard for such an analysis is the test under Article 31 of the

Vienna Convention of the Law of the Treaties i.e.

A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

(b) The ordinary meaning of the Chinese tariff schedule

240. According to Article 2 of Decree 125 the Measures apply to the supervision and

administration of imported automotive "parts" that are deemed "whole vehicles".

This conceptual distinction between parts and whole or complete vehicles

corresponds in general terms with the similar distinction under the Chinese tariff

schedules.

241. As described above, the Chinese tariff schedule is based on the Harmonised

System nomenclature. Different products fall into chapters (two digit code

number), headings (four digit code number) and subheadings (six and eight digit

code number).

242. Under the Chinese tariff schedule, motor vehicles and their parts i.e. "vehicles

other than railway or tramway rolling-stock, and parts and accessories thereof" are

classified under chapter 87 of the HS code.

243. It is not disputed that the vehicles that fall under the Measures subject to this

dispute fall, pursuant to Article 3 of Decree 125, under headings 87.02, 87.03 and

87.04. These three headings are entitled

- 87.02 Motor Vehicles for the transport of ten or more persons, including the driver

- 87.03 Motor Cars and other motor vehicles principally designed for the transport of persons (other than those of heading No 8702), including station wagons and racing cars)

- 87.04 Motor Vehicles for the transport of goods

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244. The common nominator under all three headings is "motor vehicle(s)", which are

divided into different headings on the basis of their principal use.

245. The general dictionary meaning of "motor vehicle" is "a road vehicle powered by

an internal-combustion engine"153. It is clear that a "motor vehicle" denotes

complete or whole vehicles. Indeed, the disputed Measures refer to "whole"

vehicles. The general dictionary meaning of "whole" is "complete, total" or

something "not divided into parts; not broken up or cut into pieces; entire"154. For

all practical purposes of this case, the words "whole", "complete" and "not divided

into parts" are therefore synonymous.

246. The general dictionary meaning of a "part" is "portion or division of a whole".155

"Part" is therefore the opposite of "whole" or "complete". For the purposes of this

case, a more specific definition is "any of the manufactured objects that are

assembled together to make a machine or instrument, especially a motor

vehicle"156.

247. A part of a vehicle by definition is a part or a portion or division of a whole or

complete vehicle. There is no logical or semantic basis for considering or

"deeming" an automotive "part" as a complete or "whole vehicle". Indeed, the

whole raison d'être of a part of a motor vehicle is that it will eventually become a

part of a complete vehicle after assembly, fitting, equipping and other processing

and manufacture. Otherwise a part would always remain a part and would not

'fulfil its natural destiny' to become a part of a whole vehicle. A part of a whole

vehicle has no use as such and its only function is to be fitted together with other

parts in order to build a whole vehicle.

248. As the Chinese tariff schedule clearly and unambiguously provides for separate

tariff lines for complete motor vehicles on the one hand, and parts and accessories

of such motor vehicles on the other hand, the classification (or "deeming") of

automotive parts as complete or whole vehicles is, already on the basis of the

ordinary meaning of the terms "whole" or "complete" motor vehicle as compared

153 Exhibit JE – 34. 154 Ibid. 155 Ibid.

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with "part" of motor vehicles not only a manifest error but a contradiction in

terms.

(c) Contextual analysis

249. As the contradiction is so manifest, there should in principle be no need for a

detailed examination of the Measures and the Chinese tariff commitments in their

context. i.e. under the other terms of the product description contained under the

relevant headings let alone the broader context of other headings of Chapter 87 of

the Chinese tariff schedule. As China uses the Harmonized System in its tariff

classification, the Harmonized System is also context for the purposes of

interpreting China's tariff commitments.

250. Even when the ordinary meanings of "whole or complete motor vehicles" as

compared with "part(s)" of such vehicles are examined in their context, there is

nothing that supports the view that parts or some parts for motor vehicles could be

classifiable under the relevant headings covering complete motor vehicles. As

described above, "Parts and accessories of the motor vehicles of headings Nos

87.01 to 87.05" are classified under heading 87.08 with the exception of certain

engine parts that fall under chapters 84 and 85.

251. However, there are some very exceptional situations where the general

explanatory note to Chapter 87 of the Harmonized System foresees that an

incomplete or unfinished vehicle may be classified as the corresponding complete

or finished vehicle provided it has the essential character of the latter, as for

example:

(A) A motor vehicle, not yet fitted with the wheels or tyres and battery.

(B) A motor vehicle not equipped with its engine or with its interior fittings.

(C) A bicycle without saddle and tyres.157

156 Ibid. 157 Exhibit JE – 37.

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252. Clearly, only the two first examples are relevant for the case. These examples

demonstrate the narrowness of the permissible exceptions. There is no doubt that

these examples refer to a product that must already visually be identifiable as an

almost complete motor vehicle where only some parts are not yet fitted on or the

vehicle is not equipped with some elements. The exceptions are not based on a

distinction between parts and complete vehicles but on how close to a final

complete vehicle a given product is. The degree of the manufacturing i.e. "fitting"

and "equipping" is important.

253. The narrowness of the possibility to classify an incomplete or unfinished vehicle

as the corresponding complete or finished vehicle is even clearer when the general

explanatory note to chapter 87 is read in light of the wording and the structure of

the various relevant headings and their more specific interpretative notes.

254. The different situations where parts can be Deemed Whole Vehicles under Article

21 of Decree 125 should be examined under the relevant tariff headings. This

analysis will begin with Article 21(2)(b) and (c) followed by Article 21(2)(a), then

Article 21(1) and finally Article 21(3).

i) Article 21(2)(b) and (c) of Decree 125

255. As described above, the structure of chapter 87 of the Chinese tariff schedules

consists also of headings 87.06 "Chassis fitted with engines for motor vehicles of

headings Nos. 87.01 to 87.05" and 87.07 "Bodies (including cabs), for the motor

vehicles of headings 87.01 to 87.05" i.e. the intermediate categories between

complete vehicles and parts thereof. These two headings are clearly dealing with

situations where some automotive parts and accessories are already fitted together

with other such parts creating a combination that is destined to be fitted together

with other parts in order to build a complete or whole vehicle.

256. The explanatory note to heading 87.06 is particularly interesting.158 It states as

follows:

158 Exhibit JE – 37.

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This heading covers the chassis-frames or the combined chassis-body framework (unibody or monocoque construction), for the motor vehicles of headings 87.01 to 87.05, fitted with their engines and with their transmission and steering gear and axles (with or without wheels). That is to say, goods of this heading are motor vehicles without bodies.

The chassis classified in this heading may, however, be fitted with bonnets (hoods), windscreens (windshields), mudguards, running-boards and dashboards (whether or not equipped with instruments). Chassis also remain classified here whether fitted with tyres, carburettors or batteries or other electrical equipment. However, if the article is a complete or substantially complete tractor or other vehicle it is not covered by this heading.

The heading also excludes:

(a) Chassis fitted with engines and cabs, whether or not the cab is complete (e.g., without seat) (headings 87.02 to 87.04) (see Note 3 to this Chapter).

(b) Chassis not fitted with engines, whether or not equipped with various mechanical parts (heading 87.08).

257. The product foreseen under heading 87.06 is clearly in a very advanced stage of

manufacture. Indeed, as explicitly stated by the note: "goods of this heading are

motor vehicles without bodies". Yet, such goods are explicitly not classifiable as

complete or finished vehicles.

258. "A chassis fitted with engines" falls within the scope of Article 21(2)(b) and (c) of

Decree 125. Indeed, "a chassis fitted with engines" not only consists of one of the

two "main assemblies" i.e. the "engine" but also includes or may include all the

"other assemblies" as defined under Article 4 of Decree 125 i.e. the "chassis

assembly", the "transmission assembly", the "drive-axle assembly", the "non-drive

axle assembly", the "steering system" and the "brake system". As clearly stated

under the interpretative note to heading 87.06, "goods of this heading are motor

vehicles without bodies".

259. The Chinese tariff schedule for tariff line 87.06 provides for a bound rate of duty

of between 8 to 20 % depending on the vehicle type for which the "chassis fitted

with engines" is to be used. The overwhelming majority of the vehicle types that

fall within the scope of the Measures and for which the "chassis fitted with

engines" would be used fall within tariff line 8706.0090 "other". The final bound

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rate of duty for this tariff line is 10 % as of 1 July 2006. In any event, all bound

rates of duty for "chassis fitted with engines" under heading 87.06 are well below

the final bound rate of duty (normally 25 %) for whole/complete vehicles.

260. In other words, the fact that under the Measures "a chassis fitted with engines"

would be deemed a "whole vehicle" and subject to the generally 25 % duty for

complete vehicles is a manifest breach of the bound rates of duty of China under

its tariff schedule and consequently a breach of Article II of the GATT 1994.

ii) Article 21(2)(a) of Decree 125

261. Article 21(2)(a) of Decree 125 in turn covers the situation whereby the two main

assemblies, (the vehicle body and engine), are imported for the purposes of

manufacturing a complete vehicle. In other words, this category under the

contested Measures foresees a situation where the vehicle body and the engine are

imported together or separately but without being fitted together.

262. Such a situation is manifestly far away from the categories foreseen by the

Chinese tariff schedule examined in the light of the general explanatory note to

Chapter 87 whereby an incomplete or unfinished vehicle may be classified as the

corresponding complete or finished vehicle provided it has the essential character

of the latter.

263. Indeed, the Chinese tariff schedules 87.07, 84.07 and 84.08 cover respectively

- Bodies (including cabs), for the motor vehicles of headings Nos. 87.01 to 87.05

- Reciprocating piston engines of a kind used for the propulsion of vehicles of Chapter 87 (see 8407.3100, 8407.3200, 8407.3300, 8407.3410 and 8407.3420) and

- Compression-ignition internal combustion piston engines (diesel or semi-diesel engines) of a kind used for the propulsion of vehicles of Chapter 87 (see 8408.2010 and 8408.2090).159

264. There is no basis in the Chinese tariff schedules or in the notes to the Harmonized

System that would allow imposing a different tariff than specifically indicated

159 Exhibit JE – 2.

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under the relevant Chinese tariff lines just because the engine and the body are

imported in order to be manufactured and fitted together. These products, or

"assemblies" under Decree 125, are subject to their own very specific headings of

the Chinese tariff schedule.

265. With the exception of certain kind of diesel or semi-diesel engines, the final bound

rate of duty of bodies and relevant engines is 10 % or less as of 1 July 2006. Under

the Measures, the combined importation of the body and the engine would result in

the imposition of the whole vehicle duty of 25 % on the imported parts.

266. The fact that under the Measures the imported vehicle body and the engine would

be deemed a "whole vehicle" and subject to the generally 25 % duty for complete

vehicles under tariff lines 87.02 to 87.04 is a manifest breach of the bound rates of

duty of China under its tariff schedule and consequently a breach of Article II of

the GATT 1994.

iii) Article 21(1) of Decree 125

267. Another category of products that under the Measures is "deemed" a whole or

complete vehicle is identified under Article 21(1) of Decree 125: "imported

automotive parts are deemed whole vehicles when CKD or SKD kits are imported

to assemble vehicles". On the basis of Article 2 of Decree 125, CKD refers to

Completely Knocked-Down and SKD to Semi Knocked-Down kits. Although the

Measures do not provide for an exhaustive definition of what a CKD or an SKD

consist of, it is assumed that such kits consist of all the parts necessary to

manufacture a vehicle or an "assembly". In other words, such kits consist of all the

necessary parts of a whole product packaged and imported together. The

difference between a complete product and a knocked-down kit is that for a

complete vehicle the process of manufacturing has been completed whereas a kit

provides for the necessary parts in order to manufacture a complete vehicle. A

CKD is a completely unassembled combination of all required parts and a SKD

consists of partially assembled, fitted, equipped and/or processed combinations of

parts that together would make up the complete vehicle after the completion of the

manufacturing process.

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268. Under chapter 87 of the Harmonised System, "fitting" and "equipping" are

important criteria of tariff classification. This is illustrated throughout the notes

under the chapter. As cited above, the general notes for the chapter state in

relevant part that "an ….. unfinished vehicle is classified as the corresponding

finished vehicle provided it has the essential character of the latter….., as for

example

(A) A motor vehicle, not yet fitted with the wheels or tyres and battery.

(B) A motor vehicle not equipped with its engine or with its interior fittings

….."160 [emphasis added]

269. Similarly, under headings 87.06 and 87.07 of the Harmonized System "fitting" and

"equipping" are decisive notions for classification.

270. In a completely knocked-down kit nothing or very little is fitted or equipped. A

CKD consists of a complete set of parts that after fitting, equipping and other

processing would make up a complete motor vehicle. There is no basis under the

Chinese tariff schedules or chapter 87 of the Harmonised System that would allow

for a CKD to be deemed or classified a whole vehicle. Indeed, many of the parts

would fall under chapter 84 or even chapter 85. The fact that they are packaged

together with parts that fall under heading 87.08 cannot alter their essential

character and hence tariff classification. They remain parts until they are fitted and

processed together as a complete vehicle.

271. As automotive parts are generally subject to a bound rate of duty of 10 % or less,

the classification as complete vehicles and hence the imposition of the

considerably higher complete vehicle duty on CKDs is inconsistent with the

commitment of China under its tariff schedule and consequently under Article II of

the GATT 1994.

272. With regard to SKDs the situation may, in certain particular circumstances, be

slightly more complex. Assuming, arguendo, that "a chassis fitted with engine"

(subject as such to tariff line 87.06) is packaged together with the vehicle "body"

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(subject as such to tariff line 87.07) for the purposes of importation, it would seem

clear that the package would still consist of two separate products, one classified

under heading 87.06 and the other under 87.07. It is only if these two products are

fitted together that the end result could be classified as a complete vehicle.161

273. SKDs will not attain the necessary degree of fitting and equipping to be classified

as complete vehicles. For instance, engines are subject to specific tariff lines under

headings 84.07 and 84.08 and bodies (including cabs) under 87.07. Even if engines

and bodies, which themselves consist of parts falling as such under tariff line

87.08, would be packaged together with all the other necessary parts for

manufacturing a complete vehicle, the engines, bodies and other parts would

remain subject to their specific tariff lines and therefore not classifiable as

complete vehicles. The reason is simple: the degree of fitting or equipping is not

sufficient to make such SKDs sufficiently similar to a complete vehicle in order to

have "the essential character" of a finished vehicle.

274. It should also be emphasised that in its Accession Protocol China made the

commitment according to which if China created tariff lines for completely

knocked-down kits or semi-knocked down kits for motor vehicles, "the tariff rates

would be no more than 10 per cent."162 This is entirely consistent with SKDs and

CKDs being subject to the relevant tariff rates on vehicle parts as demonstrated

above. For all practical purposes, China has, through the imposition of the whole

vehicle duty on SKDs and CKDs under the Measures, created a disguised tariff

line on such kits and imposed a tariff rate of 25 % i.e. well above 10 per cent.

275. By imposing generally the tariff of complete vehicles on SKDs and CKDs instead

of the lower tariff for the relevant automotive parts and components, China has

acted inconsistently with its obligations under Article II of the GATT 1994.

160 Exhibit JE – 37. 161 See point a) of the Explanatory Note to heading 87.06. Exhibit JE – 37. 162 Paragraph 93 of the Working Party Report, Exhibit JE – 26.

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iv) Article 21(3) of Decree 125

276. Finally, the last category of imported parts that the Measures "deem" or classify as

whole vehicles is provided for under Article 21 (3) of Decree 125, which states

that "when the aggregate price of imported parts attains 60 % or more of the

complete vehicle price for the vehicle model in question", imported parts are

deemed whole vehicles.

277. In the light of the analysis made already above, this category does not call for

much further observations. It provides for a criterion, which can not even remotely

be associated with the basic categorisation of products under chapter 87 of the

Chinese tariff schedules and the HS nomenclature. This criterion does not even

attempt to use any technical language to disguise the inconsistency between the

Measures and the Chinese tariff schedules and hence Article II GATT. Imported

parts in any random configuration will be classified as complete or whole vehicles

as long as their aggregate price attains 60 % or more of the complete vehicle price.

By definition, a criterion of 60 % of the aggregate price of the parts not only

means that the parts are not necessarily fitted and/or equipped together but also

means that fundamentally important parts may be missing. This is a manifest

breach of Article II of the GATT 1994 as the full vehicle duty is imposed on

automotive parts that under the Chinese tariff schedules are subject to a tariff of 10

% or less.

(d) Object and purpose

278. The Measures classify parts of products as complete products in a context where

its tariff schedules provide for a clear separation between the products and parts

thereof. The Measures also provide for considerable unpredictability in terms of

when a part of a product is "deemed" to be the complete product and subject to a

much higher tariff. This goes to the very heart of the WTO agreement and the

GATT 1994.

279. The European Communities considers that the Measures fundamentally undermine

the object and purpose of the WTO agreement and the GATT namely "the security

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and predictability of the reciprocal and mutually advantageous arrangements

directed to the substantial reduction of tariffs and other barriers to trade".163

(e) Conclusion

280. As demonstrated above, by applying the tariffs for imported complete vehicles

(generally 25 %) on imported automotive parts (generally subject to a bound rate

of 10 % or less) China has failed to accord to the commerce of the European

Communities treatment no less favourable than that provided for in the appropriate

Part of the appropriate Schedule annexed to the GATT. China has failed to exempt

products, which are the products of territories of the European Communities, on

their importation into China's territory, from ordinary customs duties in excess of

those set forth and provided in China's Schedule. In the alternative, China has

failed to exempt such products from all other duties or charges of any kind

imposed on or in connection with the importation in excess of those imposed on

the date of China becoming a Member or those directly and mandatorily required

to be imposed thereafter by legislation in force in the importing territory on that

date.

281. Consequently, the European Communities considers that the Measures are

inconsistent with Article II:1 (a) and (b) of the GATT 1994.

E. The Measures are inconsistent with Article 3 of the Agreement on Subsidies and Countervailing Measures

1. Introduction

282. The European Communities has demonstrated above that the Chinese Measures

are internal charges. Were they alternatively seen as border charges, they would be

inconsistent with Article II of the GATT 1994. Should the Panel find that the

Measures are border charges and, secondly, that China is entitled to accord to the

imports of auto parts the treatment it provides for vehicles in its Schedule, quod

163 Appellate Body Report, EC – Chicken cuts, at para. 243.

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non, then the Measures would in any case be a prohibited subsidy pursuant to

Articles 3.1(b) and 3.2 of the Agreement on Subsidies and Countervailing

Measures (hereafter "SCM Agreement") which state as follows

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

(…)

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

3.2 A Member shall neither grant nor maintain subsidies referred to in paragraph 1.

283. The European Communities will establish below that the Measures constitute a

financial contribution within the meaning of Article 1.1(a)(1)(ii) of the SCM

Agreement, confer a benefit within the meaning of Article 1.1(b) of the SCM

Agreement and are contingent upon the use of domestic over imported goods

within the meaning of Article 3.1(b) of the SCM Agreement. Consequently, they

are deemed to be specific pursuant to Article 2.3 of the SCM Agreement.

2. The Measures constitute a subsidy within the meaning of Article 1 of the SCM Agreement

284. Article 1.1 of the SCM Agreement provides in relevant part:

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: (…)

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

(…)

and

(b) a benefit is thereby conferred.

(footnote omitted).

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(a) Financial contribution

285. The Measures constitute a financial contribution within the meaning of Article

1.1(a)(1)(ii) of the SCM Agreement. Article 1.1(a)(1)(ii) states that there is a

financial contribution where “government revenue that is otherwise due is

foregone or not collected (e.g., fiscal incentives such as tax credits).”

286. In United States – FSC, the Appellate Body interpreted this provision in the

following way:

In our view, the "foregoing " of revenue "otherwise due" implies that less revenue has been raised by the government than would have been raised in a different situation, or, that is, "otherwise". Moreover, the word "foregone" suggests that the government has given up an entitlement to raise revenue that it could "otherwise" have raised. This cannot, however, be an entitlement in the abstract, because governments, in theory, could tax all revenues. There must, therefore, be some defined, normative benchmark against which a comparison can be made between the revenue actually raised and the revenue that would have been raised "otherwise".164

287. Thus, the relevant analysis in assessing whether “government revenue that is

otherwise due is foregone or not collected” is to compare the revenues due under

the contested measure and the revenues that would have been raised otherwise

taking into account a normative benchmark governing such comparison.

288. In the present case, the appropriate benchmark for comparison is the revenue that

China raises through duties on imports of auto parts that are Deemed Whole

Vehicles within the meaning of Article 21 of Decree 125. China has established a

duty rate which typically amounts to 25% of the value of the parts. If the local

content requirements of Article 21 of Decree 125 are not satisfied, this duty would

be paid on imports of auto parts. If the imports, on the other hand, satisfy the local

content requirements of Article 21 of Decree 125, China has, in the words of

United States – FSC, "given up an entitlement to raise revenue that it could

'otherwise' have raised"165. More specifically, by charging this second category of

parts imports with duties of generally only 10%, China has ignored the "definitive,

164 Appellate Body report in United States – FSC, at para. 90. 165 Appellate Body report in United States – FSC, at para. 90.

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normative benchmark" that it established for the first category of parts imports

and, thus, has forgone "government revenue that is otherwise due".

(b) Benefit

289. The Measures also confer a benefit within the meaning of Article 1.1(b) of the

SCM Agreement.

290. According to the Appellate Body in Canada – Measures Affecting the Export of

Civilian Aircraft, the

word "benefit", as used in Article 1.1(b), implies some kind of comparison. This must be so for there can be no “benefit” to the recipient unless the “financial contribution” makes the recipient “better off” than it would otherwise have been, absent that contribution.166

291. Vehicle manufacturers which satisfy the local content requirements of Article 21

of Decree 125 are financially "better off" than those which do not. They do not

have to pay the higher import duties for parts of typically 25% and are instead only

charged at 10%. They receive a benefit in the amount of the difference between

the two duty rates.

292. Consequently, the Chinese measure constitute a "subsidy" within the meaning of

Article 1.1.(a)(1)(ii) of the SCM Agreement.

3. The subsidy is contingent upon the use of domestic over imported goods

293. According to Article 3.1(b) of the SCM Agreement in conjunction with Article 3.2.

thereof, a Member shall neither grant nor maintain

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

166 Appellate Body report in Canada – Aircraft, at para. 157.

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294. In Canada – Autos, the Appellate Body interpreted the word "contingent" in the

following way167

In our discussion of Article 3.1(a) in Section VI of this Report, we recalled that in Canada – Aircraft we stated that "the ordinary connotation of 'contingent' is 'conditional' or 'dependent for its existence on something else'." Thus, a subsidy is prohibited under Article 3.1(a) if it is "conditional" upon export performance, that is, if it is "dependent for its existence on" export performance. In addition, in Canada – Aircraft, we stated that contingency "in law" is demonstrated "on the basis of the words of the relevant legislation, regulation or other legal instrument." (emphasis added) As we have already explained, such conditionality can be derived by necessary implication from the words actually used in the measure. We believe that this legal standard applies not only to "contingency" under Article 3.1(a), but also to "contingency" under Article 3.1(b)of the SCM Agreement. (footnotes omitted)

295. Thus, "contingent" under Article 3.1(b) of the SCM Agreement means

"conditional" or "dependent for its existence on something else" while the

conditionality can be derived by necessary implication from the words actually

used in the measure.

296. Under the Measures, the benefit of the lower duty rate of typically 10% is only

conferred if vehicle manufacturers satisfy the local content requirements of Article

21 of Decree 125. Thus, the Measures contain a clear conditionality.

297. This conditionality also relates to "the use of domestic over imported goods".

Imports of auto parts satisfy the local content requirements of Article 21 of Decree

125 if vehicle manufacturers use sufficient domestic parts instead of imported

parts in order to stay below the relevant local content thresholds.

298. Consequently, the Measures are conditional upon the use of domestic auto parts

over imported auto parts. Therefore, they are also deemed to be specific within the

meaning of Article 2.3 of the SCM Agreement.

167 Appellate Body Report in Canada- Autos, at para. 123.

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4. Conclusion

299. As demonstrated above, the Measures constitute subsidies within the meaning of

Article 1.1(a)(1)(ii) of the SCM Agreement and are contingent upon the use of

domestic over imported goods within the meaning of Article 3.1(b) of the SCM

Agreement. Thus, they are prohibited subsidies inconsistent with Article 3 of the

SCM Agreement.

IV. CONCLUSION

300. For the reasons pointed out above the European Communities respectfully requests

the Panel to find that China has violated its WTO obligations.

301. The European Communities considers that

- The Policy on Development of the Automotive Industry, issued on May 21, 2004, by China’s National Development and Reform Commission as Order No. 8;

- “Administrative Measures on Importation of Automotive Parts Deemed Whole Vehicles”, issued as Decree 125 on February 28, 2005 by China’s General Administration of Customs, NDRC, Ministry of Finance, and Ministry of Commerce in accordance with the Automotive Policy Order;

- “Rules for Verifying whether Imported Automotive Parts are Deemed Whole Vehicles”, issued as Public Announcement No. 4 by Customs on March 28, 2005, in accordance with Decree 125.

are contrary to China's obligations pursuant to:

- Article 2 of the TRIMs Agreement in conjunction with paragraph 1(a) and 2(a) of the Illustrative List annexed to the TRIMs Agreement

- Article III, paragraphs 2, 4 and 5 of the GATT 1994

- Article II:1(a) and (b) of the GATT 1994;

- Article 3.1(b) together with Article 3.2 of the SCM Agreement

- The WTO Agreement, as set out in the Accession Protocol of China, in particular Part I, paragraphs 7.2 and 7.3 thereof and in paragraph 203 of the Working Party on the Accession of China in conjunction with Part I,

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paragraph 1.2 of the Accession Protocol, and paragraph 342 of the Working Party Report on the Accession of China.

302. The European Communities requests the Panel to recommend that China bring

these Measures in conformity with its obligations under the corresponding covered

agreements.

303. Furthermore the EC requests the Panel to recommend, pursuant to Article 4.7 of

the SCM Agreement that China withdraw its prohibited subsidies without delay.

The EC respectfully requests that the Panel specify pursuant to Article 4.7 of the

SCM Agreement that the time period for withdrawal be 90 days after the DSB

adopts its recommendations and rulings in this dispute.

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TABLE OF JOINT EXHIBITS ("JE") JE-1 WTO, Accession of the People’s Republic of China, Decision of 10 November

2001, WT/L/432, November 23, 2001, online: http://docsonline.wto.org/.

JE-2 WTO, Schedule CLII to the Accession of the People’s Republic of China, WT/L/432, November 23, 2001, at pp. 67, 292-373; online: http://docsonline.wto.org/.

JE-3 Asia Pulse, “Sino-foreign joint ventures top Chinese auto sales in 2006”, January 9, 2007.

JE-4 Global Insight, Global Insight Report: China (Automotive), January 31, 2007.

JE-5 Automotive News/Automotive News Europe (Supplement), 2006 Guide to China’s Auto Market, May 1, 2006.

JE-6 Agence France Presse, “China auto sales seen spreading to smaller cities in 2007”, January 29, 2007.

JE-7 BBC News, “Chinese car market is world No 2”, January 11, 2007, online: http://news.bbc.co.uk/2/hi/business/6252215.stm.

JE-8 Asia Pulse, “China becomes world’s third largest auto producer in 2006”, January 17, 2007.

JE-9 People’s Daily Online, “China stands as world’s 2nd largest auto market,” January 13, 2006, online: http://english.peopledaily.com.cn/200601/13/eng20060113_235259.html.

JE-10 The Economist, “Carmaking in China: The fast and the furious”, November 25, 2006.

JE-11 Shanghai Daily, “China’s car industry on fast track”, December 27, 2006, online: http://en.ce.cn/Industries/Auto/200612/27/t20061227_9907488.shtml.

JE-12 Asia Pulse, “Chinese auto makers race to the bottom”, February 9, 2007.

JE-13 Embassy of China in the United States, People’s Daily, “China becomes world’s 2nd largest auto market”, January 16, 2006, online http://www.china-embassy.org/eng/gyzg/t231212.htm.

JE-14 Ernst & Young, China’s Automotive Sector – At the Crossroads, 2005.

JE-15 Reuters, “China to introduce permits for auto exports”, January 3, 2007.

JE-16 Industry Week, “China plans to up auto parts exports by ten fold” (Agence France Press), November 21, 2006, online: http://www.industryweek.com/ReadArticle.aspx?ArticleID=13111.

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JE-17 Agence France Presse, “Auto defects up in China amid price war”, November 20, 2006.

JE-18 The Policy on Development of the Automotive Industry (Order No. 8), May 21, 2004, NDRC.

JE-19 KPMG, China Automotive and Components Market 2005, November 2005.

JE-20 KPMG, Automotive and Components Market in Asia, March 2005.

JE-21 Morgan Stanley, Chinese Auto Market: Reading the Tea Leaves, February 17, 2004, online: www.uscc.gov/hearings/2004hearings/written_testimonies/04_09_23wrts/stephen_girsky.pdf .

JE-22 Booz Allen Hamilton, The Road Ahead: China’s Passenger Vehicle Market in 2015, March 2006, online: http://www.boozallen.com/publications/article/1672938.

JE-23 Automotive News/Automotive News Europe (Supplement), Guide to China’s Auto Market, May 2, 2005.

JE-24 Formal Policy on Development of Automotive Industry, February 19, 1994.

JE-25 Dic Lo, Market and Institutional Regulation in Chinese Industrialization, 1978-94 (New York: St. Martin’s Press, 1997), at p. 189.

JE-26 WTO, Report of the Working Party on the Accession of China, WT/ACC/CHN/49, October 1, 2001, online: http://docsonline.wto.org/.

JE-27 Decree 125, “Administrative Measures on Importation of Automotive Parts Deemed Whole Vehicles”, issued February 28, 2005 jointly by China’s General Administration of Customs, NDRC, Ministry of Finance and Ministry of Commerce in accordance with the Automotive Policy Order, effective April 1, 2005.

JE-28 Public Announcement No. 4, “Rules for Verifying whether Imported Automotive Parts are Deemed Whole Vehicles”, issued March 28, 2005 by China’s General Administration of Customs in accordance with Decree 125.

JE-29 Customs General Administration Joint Bulletin No. 38, July 5, 2006.

JE-30 “Classification of Power-Driven Vehicles and Trailers”, General Administration of Quality Supervision, Inspection and Quarantine, National Standard GB/T 15089-2001).

JE-31 “Procedures on Customs Control over Bonded Areas”, approved by the PRC State Council June 10, 1997, promulgated by Customs on August 1, 1997.

JE-32 Order No. 105 of Customs, “Provisions of the Customs of the People’s Republic of China on the Administration of Bonded Warehouses and the

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Goods Stored Therein”, promulgated December 5, 2003 , effective February 1, 2004.

JE-33 Order No. 63 of the PRC President, “Law of the People’s Republic of China on Administrative Penalty”, promulgated March 17, 1996, effective October 1, 1996.

JE-34 Shorter Oxford English Dictionary, 5th ed. (Oxford: Oxford University Press, 2002), at pp. 1841, 2105, 2106, 2427, 2516, 2542 and 3633.

JE-35 World Customs Organization, International Convention on the Harmonized Commodity Description and Coding System, as amended by the Protocol of Amendment , June 24, 1986, entered into force January 1, 1988.

JE-36 World Customs Organization, Fact Sheet, “The Harmonized System: The Language of International Trade”, online: http://www.wcoomd.org/ie/En/AboutUs/aboutus.html.

JE-37 Harmonized Commodity Description and Coding System – Explanatory Notes, 4th ed. (2007), Vol. 5, Chapter 87, “Vehicles other than railway or tramway rolling-stock, and parts and accessories thereof”.