Shijian Mo, John --- "A Critical Examination of Chinese Position in the Auto Part Dispute" [2006] JCULawRw 9; (2006) 13 James Cook University Law Review 167

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The most recent case which illustrates China’s position on the World Trade Organization (WTO) dispute settlement system is the current case known as Measures Affecting Imports of Automobile Parts (the China-Auto Part Dispute) which was brought to the WTO panel proceedings by the US, EU and Canada respectively.^[1] Argentina, Australia, Brazil, Taipei, Japan, Mexico and Thailand have reserved third party rights in the proceeding.^[2]

This is an important case because it is the first time in China’s WTO experience when it has been forced into panel proceedings as an unwilling respondent who nevertheless has taken a seemingly tough position on the complaints. Before January 2007, China experienced two brief encounters with other WTO members as a potential respondent: the first, in 2004, was the complaint by the US against China’s tax rebate on semiconductors, which was resolved during the consultation phase;^[3] the second, in 2005, also brought by the US, concerned China’s antidumping duties on Kraft linerboard, which was resolved on the day when the US was to initiate the dispute, following a notice to China that the dispute would be filed.^[4] On the previous occasions, China appeared to be very reluctant to become a respondent in panel proceedings and demonstrated a willingness to settle the disputes through consultations or mutual discussions. However, in the present case, China has taken a tougher position, insisting that it was entitled to impose the measures complained about by the US, EU and Canada for the purpose of enforcing its right to collect tax on imported cars. Will China succeed?

For the purpose of objectively and logically understanding the present dispute and its implications, this paper will discuss the relevant issues from several perspectives: such as the background of the dispute, major arguments of the parties to the present dispute, and legal merits of the major arguments of the parties. In conclusion, the end of the paper will summarise the major points raised and discussed.

II. BACKGROUND OF THE PRESENT DISPUTE

The present dispute started from the promulgation of the Measures for the Administration of Importation of Automotive Parts and Components for Complete Vehicles (Decree No. 125) (the ‘Measures’) issued jointly in 2005 by the General Administration of Customs, the National Development and Reform Commission, the Ministry of Finance and the Ministry of Commerce, and the Rules for Determining Whether Imported Automotive Parts and Components Constitute Complete Vehicles also issued in 2005 by the General Administration of Customs (Public Announcement No. 4). Both regulations entered into force on 1^st April 2005. The two sets of regulations appeared to have taken the same position as the Policy on Development on Automotive Industry issued by the National Development and Reform Commission on 21 May 2004 (Order No. 8) (the ‘Policy’) against the import of completely knocked down kits (CKD) or semi-knocked down kits (SKD) which contain enough auto parts to represent the essential features of a car. However, it must be pointed out that the said Policy has not expressly regulated the import of auto parts, although Article 53 of the Policy requires importers of auto parts which constitute the features of an entire car to report to the customs authority, and Article 54 of the Policy requires the government authority to enforce strictly the relevant rules on the imported cars and imported auto parts. In comparison, under the Measures, if imported auto parts constitute the features of an entire car, the imported parts are subject to the tax rate of an imported car, which was 28% prior to 30 June 2006 and became 25% after 1 July 2006.^[5] Whether or not the imported auto parts constitute the features of an entire car is decided by three alternative tests: 1) a car is assembled entirely by imported parts; 2) a car is assembled by certain percentage of the so-called assembled systems as defined in Article 4 of the Measures; 3) imported parts exceed over 60% value of a finished car.^[6] The Measures apply a higher tax to certain CKD kits and SKD kits which may otherwise be subject to a 10% tax rate agreed to by China to be applicable to the imported auto parts when China acceded to the WTO. The legitimate purpose for promulgating these policies and measures is to prevent foreign car manufactures from circumventing their liability to pay import taxes on finished cars by importing entire cars or nearly entire cars in the form of CKD kits or SKD kits.^[7] The Chinese right to apply the rules of origin to deny certain locally assembled cars from being qualified as local cars and therefore impose a higher import tax on them appears also be one of the crucial justifications held by a number of Chinese experts in support of the Measures.^[8]

The Measures received a mixed response from the worldwide public. Since the announcement of the policy in 2005, the US and EU, openly and repeatedly have criticized the policy,^[9] whilst a number of leading foreign car makers have begun to adjust their Chinese investment plans in line with the new Policy and Measures.^[10] The conflict accelerated rather rapidly in March and April 2006 when the US, EU and Canada commenced consultation processes in pursuance of the Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU).^[11] The disputes were not resolved within the 60 day consultation period. On 15 September 2006, the US, EU and Canada requested respectively the establishment of a panel to settle their disputes with China in pursuance of the DSU rules. China blocked the request as permitted by DSB practices at the September 28 DSB meeting, and the DSB accordingly deferred the establishment of panels.^[12] However, the US, EU and Canada again requested the establishment of panels to settle the dispute and accordingly the DSB established a single panel to deal with the three disputes pursuant to the relevant DSU rules.^[13] The so-called auto part dispute is now in the process of panel proceedings and thus officially China has become a respondent to the WTO panel proceedings first time in the history of the WTO dispute settlement mechanism.

The political and economic reasons for China to adopt the policy of imposing a high tax on the import of auto parts, and the rationale for China to stand firm on its policy are something of a mystery, not convincingly and logically explained by the Chinese Government. It appears that there are four major economic or political reasons to explain China’s position on the imports of CKD kits or SKD kits for auto parts. First, China may wish to encourage the pace and scope of localization of car manufacturing through the adoption of the policy^[14]. Secondly, China may wish to prevent revenue loss or to increase customs revenue through the adoption of the policy^[15]. Thirdly, China may wish to gain experience in panel proceedings^[16]. Fourthly, China may wish to have some extra time and opportunity to increase customs revenue and to implement its disputable industrial policy on cars by taking a tough position on dispute settlement.^[17] These reasons may be relevant to the present Chinese policy and Measures on the imports of auto parts.

III. MAJOR ARGUMENTS OF THE COMPLAINANTS

The US, EU and Canada have made separate complaints against the Chinese measures concerning the imports of auto parts. Most of the violations alleged by the three countries are similar, although a few are not the same. In order to have a clear overview of the major grounds set out by the three countries, the author has prepared a table to compare the grounds of allegations forwarded by the three complainants.^[18]

Summary of the major provisions allegedly to have been violated by the Chinese measures on the imports of auto parts (prepared by the author)

	US	EU	Canada
Provision
Art II:1(a) & (b) of GATT 1994	X	X	X
Art III:1 of GATT 1994		X	X
Art III:2 of the GATT 1994	X	X	X
Art III:4 of the GATT 1994	X	X	X
Art III:5 of the GATT 1994	X	X	X
Art X:1 & X:3(a) of GATT 1994			X
Art XI:1 of the GATT 1994	X	X
Art XXIII:1(b) of GATT 1994			X
Art 2.1 & paras 1(a) & 2(a) of Annex 1 of TRIMs	X	X	X
Art 2.2 of TRIMs		X
Arts 3.1(b) & 3.2 of the SCM Agreement	X	X	X

As seen from the table above, the three countries share a number of major grounds in alleging violations of WTO rules by China. Due to the limited space in this paper, the author will only deal with the issues and arguments which, in the author’s view, are crucial for determining whether a violation of WTO rules can be established. In this paper, relevant provisions whose violations have been alleged separately by the three complainants for the sake of formulating their claims will be discussed together if these provisions are related to the same or similar alleged violations.

IV. ANALYSIS OF ARTICLE II OF THE GATT

The US, EU and Canada alleged that the Chinese Measures violated Article II(a) and (b) of the GATT, but they formulated their allegations in slightly different ways. The common feature of their claims is that they all allege that the special charges imposed by China on CKD kits and SKD kits which constitute the features of an entire car are higher than what has been set out in China’s Schedule of Concessions and Commitments signed by China when acceding to the WTO. These allegations likely refer to paragraph 93 of the Working Party Report which imposes a 10% tariff binding on the imported auto parts in CKD or SKD forms. Therefore, it can be said that the alleged violation of Article II of the GATT overlaps with the alleged breach of paragraph 93. The allegation may be technically different from a breach of paragraph 93, but relies heavily on the establishment of a right to enjoy 10% tax binding in paragraph 93. For judicial economy, there is no need to discuss in great details the technical aspects of the Article II violation.

Article II of the GATT relates closely to the enforcement of the Schedule of Concessions and Commitments agreed by WTO members when joining the WTO. Applying the provision to China, this means that China is bound by the Schedule of Concessions and Commitments annexed to the Accession Protocol.^[19] The US, EU and Canada probably would allege that the Schedule of Concessions and Commitments only apply a 10% tax to imported auto parts. This allegation inevitably leads to the analysis of paragraph 93 of the Working Party Report, which will be studied specifically in the relevant sections of this article.

For the purpose of the present case, Article II 1(a) and (b) do not impose more obligations on China than paragraph 93 of the Working Party Report. However, if Article II 1(a) and (b) suggest additional obligations or emphasise different obligations, consistency of the Chinese Measures with Article II 1(a) and (b) needs special attention. Based on the information disclosed by the US, EU and Canada so far on the alleged inconsistency with Article II 1(a) and (b), the author considers that the interpretation of Article II 1(a) and (b) by the Appellate Panel in US- Import Measures on Certain Products from the EU is relevant.^[20] The panel in this case found that the US measures to impose a higher tax on certain products from the EU were inconsistent with Article II 1(a) and (b). However, the Appellate Panel drew a line between the bonding requirements and imposition of duties. In the view of the Appellate Panel, the bonding requirements adopted for ensuring a legitimate purpose cannot technically be caught by Article II 1(a) and (b), and only those duties or charges imposed for the sole purpose of increasing or collecting duties or charges fall under the scope of Article II 1(a) and (b). Since China has stated repeatedly that the higher tax imposed on the CKD kits or SKD kits which represent an entire car or more than 60% value of a finished car is applied for the purpose of preventing importers from avoiding duties on the finished cars by importing the entire cars in the form of CKD kits or SKD kits, it is highly likely the US, EU and Canadian allegation on a violation of Article II 1(a) and (b) will fail because the duties are imposed for a legitimate purpose. However, the author admits that one of the major obstacles for China to tackle when denying the said allegation is that paragraph 93 of the Working Party Report states clearly that the tariff lines to be applied by China to auto parts in CKD kits or SKD kits must be less than 10%. A direct contradiction with paragraph 93 may affect the Panel’s or Appellate Panel’s interpretation of the nature of Chinese Measures, depending its understanding of the rationale adopted by the Appellate Panel in US- Import Measures on Certain Products from the EU.

Article II 1(b) also qualifies the obligation to comply with the Schedule of Concessions and Commitments by referring to the ‘terms, conditions or qualifications set forth in that Schedule’. This qualification purports to limit the obligation of WTO members to what they have agreed to do in the Schedule of Concessions and Commitments. Given the existence of such qualification, China may argue that the obligation to impose a maximum tariff rate of 10% to auto parts is qualified by the ‘terms, conditions and qualifications’ set forth in paragraph 93 of the Working Party Report. Although it is yet to be proven what are the ‘terms, conditions and qualifications’ set forth in paragraph 93, China may argue that the ‘terms, conditions and qualifications’ implied in paragraph 93 are that 1) auto parts are really meant to be ‘parts’, which are not entire car parts taken apart merely for the purpose of being imported as ‘parts’; 2) paragraph 93 is applicable to genuine auto parts, and not to the ‘auto parts’ which constitute the features of an entire car. The Measures for the Administration of Importation of Automotive Parts and Components for Complete Vehicles have applied the expression ‘auto parts constitute the features of an entire car’ several times. The author believes that China will likely refer to such expression to formulate one of defences against the allegations made by the US, EU and Canada. However, one of the crucial issues in the present dispute on auto parts, which will certainly determine the result of the dispute, is the operation of the interpretation rules and the meaning of the good faith principle required in the interpretation.

V. ANALYSIS OF THE RELEVANT PRINCIPLES
OF THE TRIMS AGREEMENT

Article 2 of the TRIMs Agreement on Trade-Related Investment Measures (TRIMs) has been relied upon by all three complainants, who have nevertheless placed different emphases on this provision. The US has referred to Article 2(1) and paragraphs 1(a) and 2(a) of Annex of the TRIMs Agreement; the EU has referred to Articles 2(1), 2(2) and paragraph 2(a) of Annex of the TRIMs Agreement; and Canada has referred to Article 2(1) and paragraphs 1(a) of Annex of the TRIMs Agreement. The TRIMs Agreement is also an alternative ground put forward by the three complainants.

The three complainants must deal with several technical issues to prove a violation of the TRIMs Agreement. First, the TRIMs Agreement is supplementary to the GATT, and can be overridden if a measure which is inconsistent with Article 2 of the TRIMs Agreement is nevertheless justified by other rights and obligations under the GATT 1994.^[21] Secondly, a TRIM which is prohibited by the TRIMs Agreement must also be inconsistent with either Article III or Article XI of the GATT. Otherwise, a measure may appear to be TRIM, but is not the TRIM prohibited by the TRIMs Agreement. Thirdly, paragraphs 1 and 2 of Annex to the TRIMs Agreement all require the existence of an ‘advantage’ to be a condition for the operation of paragraphs 1 and 2, and therefore, it is necessary to prove the existence of an ‘advantage’ to prove the existence of the TRIMs under these paragraphs. Fourthly, TRIMs Agreement can apply to those TRIMs applied to investment activities and thus there is a need to prove the importer whose auto parts have been taxed at the rate of a finished car is also an investor in the car industry. Lastly, China may argue that the enforcement of customs law on the imports of finished car is a right protected by the GATT and therefore, the policy supporting the enforcement of customs law cannot be regarded as a TRIM even though its enforcement may appear to have the effect of encouraging localization of auto parts. These technical barriers suggest that alleged violations of the TRIMs Agreement may not be easily established.

VI. ANALYSIS OF THE RELEVANT PRINCIPLES
OF THE SCM AGREEMENT

All three complainants claim that the Chinese Measures have violated Article 3 of the Agreement on Subsidies and Countervailing Measures (‘SCM Agreement’), in particular Article 3.1(b). The crucial feature of Article 3.1(b) is a subsidy contingent on the use of domestic over imported goods. The three complainants would argue that the requirement that auto part constituting over 60% value of the finished car must be subject to the import tax of a finished car sets out a benefit which is available only if the imported auto parts do not exceed 60% threshold in a car assembled by using the auto parts. However, China would argue that the three complainants have misinterpreted the purpose of the Measures, which are meant to prevent circumvention of the import tax on finished cars. The two arguments would require the Panel or the Appellate Panel to balance two legitimate interests protected by different WTO agreements. Evidence on the nature of the Chinese Measures, ie, whether it is a preventive measure or a subsidy (or TRIM) is crucial for determining whether the allegation would succeed. In the author’s view, the argument on the alleged violation of Article 3 of the SCM Agreement may not go too far because: 1) the SCM Agreement is not directly related to the Measures in dispute; 2) the Measures in dispute may have the effect of encouraging local production, but the local production is dominated by foreign manufacturers who are also those importers subject to the restriction of the Measures, and therefore the actual local benefit would be minimal, so that there is no real ‘benefit’ for the purpose of Article 3 of the SCM Agreement; 3) paragraph 93 of the Working Party Report is directly related to the Measures in question, depending on the interpretation of the paragraph, there may not be a need to investigate in great details the alleged violation of Article 3 of the SCM Agreement.

Although the author considers the relevance of the SCM Agreement to be minimal, in previous cases, the panels or the Appellate Panel have expressed a view that an exemption of import tax in certain cases can constitute a ‘benefit’ for the purpose of the SCM Agreement.^[22] However, in the present auto part dispute, there is no tax exemption available, although different tax rates apply to imported auto parts by referring to the 60% threshold in the cars incorporating imported auto parts. Under the rules of treaty interpretation, such as good faith, ordinary meaning, context, purpose and avoidance of ambiguity, a difference in tax rates should not be construed as being a tax exemption. In addition, a benefit or advantage in Article 3.1(b) of the SCM Agreement, which is the provision relied upon by the three complaints, must be “contingent” upon the use of domestic over imported goods. In Canada – Certain Measures Affecting the Automotive Industry, the Panel observed that in order to satisfy the requirement of Article 3.1(b) of the SCM Agreement, three conditions including: manufacturing presence, ratio requirements, and CVA requirements must be met before proving an import duty exemption to be contingent upon the use of domestic over imported goods.^[23] The reasoning process is important for determining whether Article 3.1(b) of the SCM Agreement applies to the present case. Even from the technical aspect, the author considers it to be too difficult and remote to establish a contravention of Article 3.1(b) of the SCM Agreement in the present case.

VII. ANALYSIS OF PARAGRAPH 93 OF THE
WORKING PARTY REPORT

All three complainants claim a breach of paragraph 93 of the Working Party Report. In the author’s view, this allegation is most direct and most vital. In the end, it may prove to be the fatal strike to the Chinese position on the dispute. The Chinese undertaking is fairly clear in the paragraph, which states that in response to ‘questions about the tariff treatment for kits for motor vehicles, the representative of China confirmed that China had no tariff line for completely knocked-down kits for motor vehicles or semi-knocked down kits for motor vehicles. If China created such lines, the tariff rates would be no more than 10%. The Working Party took note of this commitment. The interpretation of the provision is crucial for determining whether China has an obligation not to impose a tax line over 10% on the imported auto parts. When interpreting this provision, the governing principles of interpretation, and background information, if there is any, concerning the meanings of the relevant terms of the paragraph, such as ‘CKD’ and ‘SKD’, as well as the intended purpose of this paragraph are the most fundamental issues China has to face objectively and logically in the forthcoming panel proceedings.

Treaty interpretation is one of the major issues a panel or Appellate Panel has to deal with in a WTO dispute. Articles 31 and 32 of the Vienna Convention on the Law of Treaties (‘Vienna Convention’) are the basic rules of treaty interpretation, the panel or Appellate Panel has to follow. Article 31.1 of the Vienna Convention emphasises good faith of interpretation and ordinary meanings of the term which must be read in context where the term is used and also in the light of the object and purpose of the provision concerned. This provision includes good faith approach, ordinary meaning approach and purpose approach to treaty interpretation. The three approaches to interpretation are independent of each other, and are supplementary in certain circumstances. Other subsections of Article 31 provide accessory rules for the operation of the three approaches. Article 31 of the Vienna Convention is reinforced by Article 32 of the Vienna Convention, which resorts to the support of supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion. In addition, Article 32 qualifies the effect of Article 31 by stating that the interpretation result of Article 31 should not leave the meaning of the term ambiguous or obscure, nor lead to a result which is manifestly absurd or unreasonable (the ‘effective interpretation approach’). These provisions guide the interpretation of WTO rules by the panel or Appellate Panel.

Many panel reports and appellate panel reports have illustrated vividly the operation of Articles 31 and 32 of the Vienna Convention. Although a holistic approach must be taken in the application of Articles 31 and 32, the ordinary meaning approach is usually the first step in most cases for treaty interpretation. For example, the Appellate Panel in its Report on Japan – Alcoholic Beverages dispute observed that Article 31 of the Vienna Convention provides that the words of the treaty form the foundation for the interpretive process and the interpretation must be based above all upon the text of the treaty.^[24] Thus, in United States – Measures affecting the cross-border supply of gambling and betting services,^[25] the Panel applied the ordinary meaning approach thoroughly by referring to the dictionary meanings of the essential terms, such as ‘sporting’ and ‘gambling’ in the Shorter Oxford English Dictionary (1993 Edition), the Penguin Pocket English Dictionary (1988) and the New Oxford Thesaurus of English, among others^[26]. The Panel also compared these definitions with French and Spanish dictionaries for the purpose of ascertaining the ordinary meanings of ‘sporting’ and ‘gambling’^[27]. This approach is typical of the panel or Appellate Panel when determining the ordinary meanings or literal meanings of terms in WTO agreements. The Panel in European Communities – Customs Classification of Frozen Boneless Chicken Cuts also resorted vigorously to the dictionary meanings of the crucial terms in that case, such as ‘salted’^[28]. In fact, the Appellate Panel on a number of occasions has regarded the dictionaries as being the ‘useful starting point’ for determining the ordinary meanings of terms^[29]. Such practice is crucial for determining the outcome of the present auto part dispute. In the context of paragraph 93 of the Working Party Report, the ordinary meanings of ‘completely knocked-down kits (CKD kits)’, ‘semi-knocked down kits (SKD kits)’ and ‘kits for motor vehicles’ are essential for establishing whether there is an obligation for China not to impose a tax rate higher than 10% on CKD kits or SKD kits of auto parts regardless of whether or not the auto parts may by the end constitute the features of an entire car.

The terms CKD and SKD are professional terms, not available in most language dictionaries. The author found two definitions of CKD on internet, although only one of them refers to SKD.^[30] One defines CKD as standing for ‘Completely Knocked Down’, which refers to ‘cars which are brought into the country in the form of kits. The kits are assembled locally, with a lot of the parts not supplied in the main kit sourced from local manufacturers.’^[31] The other defines CKD as:

These two definitions of CKD suggest slightly different meanings. One suggests that CKD does not necessary represent auto parts of an entire car and many parts for assembly are from local sources, but the other explicitly states that CKD represents a complete kit needed for assembling a vehicle. The first definition is in favour of the Chinese position in the sense that it leaves a possibility to argue that local content requirement is implied in the use of the term ‘CKD’ kits for auto parts. One the other hand, the second definition undermines the Chinese position badly in the sense that the expression ‘completely knocked-down’ kits for auto parts permits the import of auto parts for an entire car. The two definitions are inconsistent, although neither is conclusive or authoritative for the purpose of establishing the ordinary meanings of CKD. These two definitions found on the internet demonstrate one of the practical difficulties in the interpretation of paragraph 93 of the Working Party Report, China, the three complainants and the panel or Appellate Panel, must face if the dispute goes through panel proceedings.

The author is unable to prove convincingly the precise meanings of ‘completely knocked-down kits (CKD)’, ‘semi-knocked down kits (SKD)’ and ‘kits for motor vehicles’. Based on the forgoing discussions on CKD, the author wishes to offer his own observations on the necessary considerations or factors which will likely affect the interpretation of the three key terms of paragraph 93. First, China has to refer to authoritative linguistic and professional dictionaries to establish the ordinary meanings of these terms, if China wishes to have an objectively and reasonable understanding of these essential terms. Secondly, China must refer to the background information, if available, concerning the formation of paragraph 93, if such information directly or indirectly supports the Chinese argument that it has no obligation to apply a 10% tax rate to all CKD and SKD kits for auto parts which constitute the features of an entire car. Thirdly, the dictionary meanings or the interpretation of the terms must be adequately interpreted in good faith in the context in which they exist, taking into account the purpose of paragraph 93 as intended by the parties participating in the preparation of the Working Party Report. Fourthly, the ordinary meanings so derived must be examined in good faith through a holistic approach by referring to the purpose of paragraph 93, the relationship between paragraph 93 and other relevant WTO rules, and the relevant principles for determining the conflicts between China’s right to collect 25% (28% in 2005) tax on imported cars and its obligation not to collect more than 10% tax on CKD kits or SKD kits for motor vehicles.^[33] If China can still establish a solid and reasonable defence after having considered all these factors, it will have a good case against the complaints. Otherwise, it would have a very week case to fight on. Based on the information available now, the author’s feeling is that unless strong and conclusive evidence can be produced by China from the background information concerning paragraph 93 to suggest that ‘completely knocked-down kits (CKD), ‘semi-knocked down kits (SKD)’ and ‘kits for motor vehicles’ in paragraph 93 refer to genuine ‘auto parts’ only, rather than complete cars or major components of cars, China will lose the present dispute. In other words, it is very difficult for China to establish convincingly that the essential expressions in paragraph 93, in particular CKD and SKD, are qualified to the extent that they do not guarantee a right to import auto parts for an entire car or import auto parts which represent certain percentage of assembled systems or more than 60% value of a car assembled from the imported parts in the form of CKD kits or SKD kits under the promised tax lines of 10%.

The rules of treaty interpretation warranted by Articles 31 and 32 of the Vienna Convention guide not only the interpretation of paragraph 93 of the Working Party Report, but also the interpretation of the relationship between China’s right to collect a higher tax on imported cars and its obligation not to collect more than 10% of tax on imported auto parts. Prevention of revenue loss and enforcing its right to collect tax on imported cars are perhaps the strongest defences China can count on to win this case. China will have to argue that in the Measures complained about, there is no any benefit or advantage involved, other than the application of a particular import tax rate, and therefore, the real focus of the dispute is merely a technical point whether China is entitled to impose the tax rate on imported cars to the imports of auto parts which constitute the features of an entire car. This technical point concerns only two questions: 1) the true meaning of paragraph 93; and 2) determination of priority between China’s right to collect 25% (or 28%) until China has reduced the import tax rate to 25% in July 2006) tax on imported cars and its obligation to impose no more than 10% tax on imported auto parts regardless of what is the percentage of the auto parts in the cars assembled from these parts (if paragraph 93 is proven to be unqualified against Chinese interpretation). A delicate balance between Chinese right to impose tax on imported cars and its obligation to impose no more than 10% tax on imported auto parts has to be established by referring to the genuine and good faith interpretation of paragraph 93, in particular whether paragraph 93, by its very existence, has taken into account the potential conflict between the said right and obligation. If China cannot establish the defence that paragraph 93 is meant to apply to only auto parts which are not meant to be assembled into an entire car by themselves or to represent certain percentage of assembled systems or more than 60% value of a car assembled by using the imported auto parts, it will lose the present dispute. This is because the unambiguous words of paragraph 93 and its intended purpose will prevail over the extended right claimed by China to apply the import tax of imported cars to these imported auto parts constituting an entire car or more than 60% value of a finished car.

When discussing the merits of the complaints and defences in the present dispute, Indonesia - Certain Measures Affecting the Automobile Industry is a case deserving special attention.^[34] In this case, Japan, EC and the US complained about the Indonesian policies adopted for the purpose of encouraging and favouring cars with certain local contributions. The measures complained about related to both domestic and import tax, and only issues concerning important tax are relevant to the present auto part dispute. In the author’s view, the Chinese Government might wish to rely on the panel’s finding that unassembled product ipso facto is a like product to that product assembled.^[35] On this basis, the Chinese Government may argue that it is entitled to apply the same tax rate to unassembled auto parts imported in CKD or SCD forms. While agreeing with the conclusion that the Panel in Indonesia - Certain Measures Affecting the Automobile Industry reached in such finding, the Panel in that case appears to have based its finding on the agreed facts that the EC:

indicated that Escorts would have been ordered in groups of 20 vehicles, packaged in waterproof, pre-engineered cases. The CKD kit would have contained ‘all of the individual parts necessary to build a complete Escort, except for locally procured parts and components, such as oil and gasoline.^[37]

These facts are crucial for establishing the genuine meanings of CKD kits and SKD kits in paragraph 93 of the Working Party Report. If the meanings of the key terms in paragraph 93, such as CKD kits and SKD kits, do not exclude the possibility of importing auto parts of entire cars or nearly entire cars as auto parts into Chinese territory, China would face an impossible task of launching a successful defence based on its right to collect tax on imported cars, because an interpretation permitting China to circumvent its obligation under paragraph 93 would lead to a contradiction between China’s WTO obligations, a result which can be regarded as being manifestly absurd or unreasonable under Article 32 of the Vienna Convention.

VIII. CONCLUSION

As we have seen in the above discussions, the auto parts dispute is a complicated issue, involving different WTO rules and their interpretations. Two major issues will decide the outcome of the dispute: 1) the evidence put forward by the parties; and 2) rules of interpretation adopted by the Panel or the Appellate Panel. Given that the effect of evidence is also subject to the discretionary power of the Panel or Appellate Panel, the interpretation rules and every element concerning the interpretation will have to be thoroughly argued by the parties concerned for the purpose of establishing their cases.

If China cannot succeed in establishing the legitimacy and fairness of its interpretation of paragraph 93 of the Working Party Report and other important WTO rules, the case is meaningful to it only in three aspects: 1) it is a good experience with the WTO panel proceedings; 2) it is a good chance to clarify ambiguity in the WTO rules and reconcile direct and indirect inconsistency between certain WTO rules; 3) it is a good strategy to obtain some time for the implementation of its auto policy in China, even though the policy may have to be streamlined or modified depending on the result of the present dispute.

In terms of possible economic benefits deriving from the Measures in question, the author wishes to point out that on 5 July 2006, the General Administration of Customs, the National Development and Reform Commission, the Ministry of Finance and the Ministry of Commerce jointly issued a public Notice,^[38] announcing a decision to postpone the enforcement of the ‘60% value test’ and the test for differentiating Class A from Class B in determining the percentage of assembled systems till 1 July 2008. The reference to Class A and Class B of the assembled systems is seen in Article 19 of the Rules for Determining Whether Imported Automotive Parts and Components Constitute Complete Vehicles. The language of the said public Notice is ambiguous in the sense that it is unclear whether the test based on certain percentage of the so-called assembled systems for determining whether the imported parts have constituted the features of an entire car has been entirely postponed or only the method for differentiating Class A from Class B as mentioned in Article 19 of the Rules for Determining Whether Imported Automotive Parts and Components Constitute Complete Vehicles has been postponed. Therefore, there are two possible interpretations of the said Notice: 1) China only imposes a higher tax on cars which are assembled entirely by imported parts; or 2) China imposes a higher tax on not only cars which are assembled entirely by imported parts but also cars which contain certain percentage of the assembled systems imported as auto parts. If the first interpretation is true, the direct economic benefit flowing from the Measures in question will be minimal, because the importer can easily avoid the imposition of a higher tax by not using 100% of imported parts in their finished products in China. If the second interpretation is true, the economic benefit may be a bit more than the first interpretation, however, the measure may also be easily circumvented by not importing assembled systems or not to the prescribed percentage that warrants the imposition of a higher tax. Either way, due to the postponement of the ‘60% value test’, it is very difficult for Chinese Customs to impose a higher tax on the imported auto parts before 1 July 2008. This is why the author doubts the economic benefit argument upheld by certain Chinese officials and experts about the justification for having taken a tough position against the complaints in the present auto parts dispute.^[39] The author’s doubt is strengthened by a journal article published in November 2006, which stated two important facts: 1) the monitoring system stipulated by the Measures to track down the ultimate use of the imported auto parts for the purpose of imposing a higher tax rate on those parts constituting the features of an entire car lacked feasibility, and 2) the sale of local auto parts increased by 18.67% in 2005, which is a increasing rate actually lower than the rate in 2004 when the Measures were not in place.^[40] The two facts suggest that the Measures may not have the economic benefit claimed or believed to have by certain decision-makers in China.

As to the argument that China is able to apply the rules of origin to impose the import tax on those cars which do not meet the criteria for grating the Chinese origin to cars made in China, the author believes that there is a misunderstanding on the functions of the rules of origin by those holding such argument. The rules of origin are associated rules in the sense that they must serve a legitimate purpose and thus the use of the rules of origin itself is not the purpose and justification of such rules. The real issue moves back to the interpretation of paragraph 93 of the Working Party Report and the balance between China’s right to impose a tax rate of 25% (or 28% before 2006) on imported cars and its obligation not to impose more than 10% tax on the imported auto parts. In the light of these relevant issues, it is not enough to prove that the rules of origin can help China to prevent the importer from circumventing their obligation to pay import tax on entire cars, it is also necessary to prove that the rules of origin so applied do not contravene China’s obligation not to impose more than 10% tax on the imported auto parts. This is why the author believes that the rules of origin are not much hope in defending the Measures in dispute.

Although the author does not have much confidence in China’s the perspective of winning the present dispute, the author does not complain about China’s decision to proceed with the panel proceedings. A decision must be made one way or another when a really thorny issue arises in China’s trading relations with other WTO members, and China must learn how to use effectively the WTO dispute settlement mechanism. Doing it is the best way to learn. However, in view of the conclusions on the relevant issues reached in this paper, unless there is sufficient evidence held in confidence which strongly supports the Chinese position, the author’s feeling is that China will likely settle the dispute with the complainants sometime on the way of the proceedings, rather than standing firmly till the end of the proceeding. This is because in the author’s view, China does not receive sufficient economic benefits during the period of proceedings and implementation (if this turns out to be necessary) from the said Measures to justify its courageous gesture to fight a losing course.

However, the author also admits that due to a lack of precise data on the overall economic benefits which may likely derive from the Measures in question, China may choose to continue with the panel proceedings right to the end for the sake of economic return or something else worth doing, a common technique employed by many WTO members, such as the US, EU and Japan. In such case, economic consideration is probably the driving ‘rationale’ for China’s firm position against the complaints discussed in the paper. But, if the so-called economic consideration turns out to be ill-founded by the end, the benefit of the Chinese position in the present auto parts dispute is something warranting a lot of serious, rational, objective and logical contemplation.

^[*] PhD, Professor of Law and Dean of the Faculty of International Law, China University of Political Science and Law (CUPL), Director of the CUPL Centre for Trade Remedies, email: moshijian@vip.sina.com

^[1] See China-Measures Affecting the Imports of Automobile Parts, WTO Doc WT/DS339/8 (2006) (Request for Establishment of a Panel by the European Communities); WTO Doc WT/DS340/8 (2006) (Request for Establishment of a Panel by the United States); WTO Doc WT/DS342/8 (Request for Establishment of a Panel by Canada).

^[2] See Update of WTO Dispute Settlement Cases, WTO Doc WT/DS/OV/30 (2007) [49].

^[3] China – Value-Added Tax on Integrated Circuits, WTO Doc WT/DS309 (2004). On 18 March 2004, the US requested consultations with China concerning China’s preferential value-added tax for domestically produced or designed integrated circuits. On 14 July 2004, China and the US notified the DSB that they had reached an agreement with respect to the matter raised by the US in its request for consultations.

^[4] See, United States Trade Representative, United States Files WTO Case Against China Over Treatment of U.S. Auto Parts (2006) <http://www.ustr.gov/> at 16 October 2007.

^[6] General Administration of Customs, National Development and Reform Commission, Ministry of Finance and Ministry of Commerce, Measures for the Administration of Importation of Automotive Parts and Components for Complete Vehicles (Decree No. 125) (2005) (the ‘Measures’) Article 21.

^[7] National Development and Reform Commission, Policy on Development on Automotive Industry (Order No.8) (21 May 2004) (the ‘Policy’) Articles 53 and 54. See also the interview with spokesperson from the General Administration of Customs, Beijing Youth Daily (Beijing, China), 7 April 2005, available at http://www.yn.gov.cn/.

^[8] See, eg, Yuqing Zhang, ‘Analysis of Certain Issues Raised by the US and EU in Their Consultation Requests’ (2006) 36(5) China WTO Tribune 31-2; Xinyu Mei, ‘Inevitability of Auto Parts Dispute and the Chinese Need to Have a Case Like This’, China Car Daily, 29 September 2006.

^[9] See, eg, the report on the U.S.-China Economic and Security Review Commission hearing on China’s auto part policy, at Hong Kong Trade Development Council’s website: http://mobile.tdctrade.com/. See also, David M Lenard, ‘US, EU take China to WTO on Auto Parts’, Asia Times (Hong Kong), 1 April 2006, available at

^[10] It was reported that BMW had indicated an intention to increase its local purchase of auto parts from RMB 0.87 billion to RMB 2.4 billion in 2007 and Merced had indicated an intention to continue their operation in China under the new policy. See Guangzhou Daily, Merced Speed Up the Process of Localization (2006) at <http://www.tpbjc.gov.cn/> at 9 June 2006.

^[11] It was reported that the US and EC Delegation requested the Chinese Delegation to commence consultations on auto part dispute on 30 March 2006, and on 13April 2006 Canada requested the Chinese Delegation to commence consultations on auto part dispute. See Update of WTO Dispute Settlement Cases, WTO Doc WT/DS/OV/28 (2006) for relevant information, available at the WTO website: http://www.wto.org/.

^[13] World Trade Organization, DSB sets up panels to examine disputes on auto parts, shrimp and steel (2006)

^[14] This can be seen in the Policy on Development on Automotive Industry, issued on 21 May 2004 by the National Development and Reform Commission (Order No. 8). This was one of the documents complained about by the US, EC and Canada.

^[15] One of the major defenses adopted by China against the complaints by the US, EC and Canada is that certain importers have avoided their tax liability on the import of entire cars by way of CKD kits and SKD kits. See, for example, a short article entitled ‘China is Entitled to Impose an Import Tax on the Imported Cars Which is Higher Than the Duty on Imported Auto Parts’ reported that the officials from the Ministry of Commerce stated that the measures concerning the import of auto parts are consistent with the WTO rules because they are imposed for the purpose of preventing tax avoidance on the import of entire cars by way of CKD kits and SKD kits. Xinhua News (2006) <http://news.xinhuanet.com/> at 27 October 2006.

^[16] China has participated in many panel proceedings as a third party. There has been a strong public view that China should be more active as a complainant or respondent in these proceedings to match its position as one of the major trading powers of the WTO system.

^[17] This view has been seen in a number of unofficial views expressed by commentators on this case in China. The author has also expressed the same view in one of the newspaper reviews on the dispute. See John Shijian Mo, 21^st Century Economic Report (2006) Eview Week <http://www.eviewweek.com> at 30 October 2006.

^[18] The information is seen in China-Measures Affecting the Imports of Automobile Parts, WTO Doc WT/DS339/8 (2006) (Request for Establishment of a Panel by the European Communities); WTO Doc WT/DS340/8 (2006) (Request for Establishment of a Panel by the United States); WTO Doc WT/DS342/8 (Request for Establishment of a Panel by Canada).

^[19] Accession of the People’s Republic of China, WTO Doc Wt/L/432 (2001), Part II, Para 1.

^[21] Agreement on Trade-Related Investment Measures, Marrakesh Agreement Establishing the World Trade Organization, Annex 1A, opened for signature 15 April 1994, 1868 UNTS 186, art 2(1).

^[22] For example, in Canada – Certain Measures Affecting the Automotive Industry, WTO Doc WT/DS139/R and WT/DS142/R [10.165] (2000) (Report of Appellate Panel), the Panel observed that ‘the fact that the manufacturer beneficiaries need not pay customs duties that would otherwise be due – and that would be paid by non-qualifying manufacturers – constitutes just such an advantage. We find that the financial contribution made through the import duty exemption, therefore, confers a benefit within the meaning of Article 1.1(a)(2) of the SCM Agreement.’.

^[28] There was one panel for this dispute, but the EC requested the panel to issue two separate reports pursuant to Article 9.2 of the DSU, i.e, Complaint by Brazil, WTO Doc WT/DS269/R (2005); Complaint by Thailand, WTO Doc WT/DS286/R (2005). The two reports have the same descriptive parts and findings; the only ‘material difference’ between these separate reports is the cover page and the conclusions. The ordinary meanings of ‘salted’ are examined in sections 7.112-7.116 of the Panel Reports.

^[29] See the observation of the Appellate Panel in European Communities – Customs Classification Of Frozen Boneless Chicken Cut, WTO Doc WT/DS269/AB/R, WT/DS286/AB/R (2005) [175] (Appellate Panel Report).

^[30] One definition describes CKD as representing a complete set of knocked down parts for a whole car, and accordingly describes SKD as an ‘incomplete kit’ for car parts. See Answers.com, CKD (2007) <http://www.answers.com/> at 31 October 2007.

^[31] See Paultan.org: Paul Tan’s Raves and Rants on the Automobile Industry, Car Jargon (2006) <http://paultan.org/> at 31 October 2007.

^[33] WTO panels or the Appellate Panel have on many occasions emphasized on the importance of a holistic approach in the interpretation of WTO rules. For example, the Panel in Canada – Certain Measures Affecting the Automotive Industry observed that the three elements referred to in Article 31 – text, context and object and purpose – should be viewed as one integrated rule of interpretation rather than a sequence of separate tests to be applied in a hierarchical order. WTO Doc WT/DS139/R, WT/DS142/R (2000) [10.12] (Panel Report as modified by Appellate Body).

^[39] The economic benefit argument has never been officially adopted by the Chinese Government in the present dispute, and will never be. However, in a number of conferences attended by the author who has questioned the rationale of the present position taken by China in the auto parts dispute, a view of economic benefit or justification has been expressed by some of the officials and experts also attending the conferences.

^[40] Xiupo Wu, ‘Why China Has Postponed the Import Tax on Auto Parts Which Constitute the Features of an Entire Car’ Study of Automobile Industry (2006) 23-6.

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