United States – Conditional Tax Incentives
for Large Civil Aircraft

Report of the Panel

TABLE OF CONTENTS

1   Introduction.. 14

1.1   Complaint by the European Union. 14

1.2   Panel establishment and composition. 14

1.3   Panel proceedings. 14

1.3.1   General 14

1.3.2   Changes to the timetable. 15

1.3.3   Additional Working Procedures for the Protection of Business Confidential Information (BCI) and Highly Sensitive Business Information (HSBI) 16

1.3.4   Additional Working Procedures for the Partial Opening to the Public of the Meetings of the Panel 16

2   Factual aspects. 16

3   Parties' requests for findings and recommendations. 17

4   Arguments of the parties. 17

5   Arguments of the third parties. 17

6   Interim review... 17

7   Findings. 22

7.1   Introduction. 22

7.2   Function of the Panel, Burden of Proof, and Treaty Interpretation. 22

7.2.1   Function of the Panel 22

7.2.2   Burden of proof 23

7.2.3   Treaty interpretation. 24

7.3   Description and background of the measures at issue. 25

7.3.1   Aerospace tax measures. 25

7.3.1.1   Measures related to the B&O tax. 26

7.3.1.2   Exemptions from sales and use taxes. 27

7.3.1.3   Exemptions from taxes imposed on certain leaseholds. 28

7.3.2   Siting provisions. 28

7.3.2.1   First Siting Provision. 28

7.3.2.2   Second Siting Provision. 29

7.3.3   Legislative background and scope of the measures at issue. 30

7.4   Existence of a subsidy under Article 1 of the SCM Agreement 32

7.4.1   Arguments of the parties. 32

7.4.2   Third-party views. 33

7.4.3   Whether there is a financial contribution as "government revenue that is otherwise due is foregone or not collected". 33

7.4.3.1   B&O aerospace tax rate. 35

7.4.3.2   B&O tax credit for aerospace product development 42

7.4.3.3   B&O tax credit for property and leasehold excise taxes. 45

7.4.3.4   Computer sales and use tax exemptions. 48

7.4.3.5   Construction sales and use tax exemptions. 51

7.4.3.6   Leasehold excise tax exemption. 52

7.4.3.7   Leaseholder property tax exemption. 55

7.4.3.8   Conclusion on financial contribution. 56

7.4.4   Whether a benefit is thereby conferred. 58

7.4.5   Conclusion under Article 1 of the SCM Agreement 59

7.5   Whether the challenged measures are prohibited subsidies under Article 3.1(b) of the SCM Agreement 59

7.5.1   Arguments of the parties. 60

7.5.1.1   European Union. 60

7.5.1.2   United States. 62

7.5.2   Third-party views. 63

7.5.3   Order of analysis. 66

7.5.4   Article 3.1(b) of the SCM Agreement 67

7.5.4.1   Prohibited subsidies. 67

7.5.4.2   Article III:8(b) of the GATT 1994. 68

7.5.4.3   Contingency. 68

7.5.4.4   Other interpretive issues. 71

7.5.5   Relevant facts for the assessment of the alleged contingency. 74

7.5.5.1   The siting provisions of ESSB 5952. 74

7.5.5.2   Products at issue. 77

7.5.5.3   Other relevant facts on record. 82

7.5.6   Whether the subsidies are de jure contingent upon the use of domestic over imported goods  83

7.5.6.1   The First Siting Provision, considered separately. 85

7.5.6.2   The Second Siting Provision, considered separately. 89

7.5.6.3   The First Siting Provision and the Second Siting Provision, considered jointly. 91

7.5.7   Whether the subsidies are de facto contingent upon the use of domestic over imported goods  92

7.5.7.1   Legal standard. 93

7.5.7.2   The Panel's approach to address the European Union's claim.. 93

7.5.7.3   The First and Second Siting Provisions. 96

8   Conclusions and Recommendation.. 105

8.1   Conclusions. 105

8.2   Recommendation. 106

List of Annexes

ANNEX A

WORKING PROCEDURES OF THE PANEL

ANNEX B

ARGUMENTS OF THE PARTIES

ANNEX C

ARGUMENTS OF The THIRD PARTIES

ANNEX d

PRocedural RULINGS

WTO CASES CITED IN THIS REPORT

GATT CASES CITED IN THIS REPORT

EXHIBITS REFERRED TO IN THIS REPORT

ABBREVIATIONS USED IN THis REPORT

1  Introduction

1.1  Complaint by the European Union

1.1.  On 19 December 2014, the European Union requested consultations with the United States pursuant to Articles 4.1 and 30 of the Agreement on Subsidies and Countervailing Measures (SCM Agreement); Article XXIII:1 of the General Agreement on Tariffs and Trade 1994 (GATT 1994), to the extent incorporated by Article 30 of the SCM Agreement; and Article 4 of the Understanding on Rules and Procedures Governing the Settlement of Disputes (DSU), with respect to the measures and claims set out below.^[1]

1.2.  Consultations were held on 2 February 2015. These consultations did not lead to a mutually satisfactory solution.^[2]

1.2  Panel establishment and composition

1.3.  On 12 February 2015, the European Union requested the establishment of a panel pursuant to Articles 4.4 and 30 of the SCM Agreement, Article XXIII:2 of the GATT 1994 (to the extent incorporated by Article 30 of the SCM Agreement), and Article 6 of the DSU (as modified by Article 4.4 of the SCM Agreement, and in light of Article 1.2 and Appendix 2 to the DSU), with standard terms of reference.^[3] At its meeting on 23 February 2015, the Dispute Settlement Body (DSB) established a panel pursuant to the request of the European Union, in accordance with the provisions of Article 4.4 of the SCM Agreement and Article 6 of the DSU, with standard terms of reference.^[4]

1.4.  The Panel's terms of reference are the following:

To examine, in the light of the relevant provisions of the covered agreements cited by the parties to the dispute, the matter referred to the DSB by the European Union in document WT/DS487/2 and to make such findings as will assist the DSB in making the recommendations or in giving the rulings provided for in those agreements.^[5]

1.5.  On 13 April 2015, the European Union requested the Director-General to determine the composition of the panel, pursuant to Article 8.7 of the DSU. On 22 April 2015, the Director-General accordingly composed the Panel as follows:

Chairperson:   Mr Daniel Moulis

Members:               Mr Terry Collins-Williams

                       Mr Wilhelm Meier

1.6.  Australia; Brazil; Canada; China; India; Japan; the Republic of Korea (Korea); and the Russian Federation (Russia) notified their interest in participating in the Panel proceedings as third parties.

1.3  Panel proceedings

1.3.1  General

1.7.  The commencement of the Panel's work was delayed as a result of a lack of available resources in the World Trade Organization (WTO) Secretariat.^[6] The parties were notified of this circumstance. The Panel held its organizational meeting with the parties on 4 December 2015. After consultation with the parties, the Panel adopted its Working Procedures on 7 December 2015^[7], its timetable on 16 December 2015, and a revised timetable on 19 April 2016.

1.8.  The European Union filed its first written submission on 9 December 2015. The United States filed its first written submission on 19 January 2016. Third-party submissions were received on 26 January 2016 from Australia, Brazil, Canada, China, and Japan.

1.9.  The Panel held a first substantive meeting with the parties on 24 and 25 February 2016. A session with the third parties took place on 25 February 2016, in which oral statements were made by Australia, Brazil, China, and Japan. Written responses to questions posed by the Panel were received on 9 March 2016 from the European Union, the United States, Australia, Brazil, Canada, China, and Japan.

1.10.  The parties filed their second written submissions on 18 March 2016.

1.11.  The Panel held a second substantive meeting with the parties on 5 April 2016. Written responses to questions posed by the Panel were received on 18 April 2016. Comments by the parties on each other's responses to questions were received on 25 April 2016.

1.12.  On 9 May 2016, the Panel issued the descriptive sections of its draft report to the parties. Parties provided comments to the descriptive sections of the Panel report on 17 May 2016.

1.13.  The Panel issued its Interim Report to the parties on 6 July 2016. On 15 July 2016, the European Union and the United States each submitted written requests for review of precise aspects of the interim report. Neither party requested an interim review meeting. On 20 July 2016, each of the parties submitted comments on the other's requests for review. The Panel issued its Final Report to the parties on 29 July 2016.

1.3.2  Changes to the timetable

1.14.  On 5 January 2016, the United States requested an adjustment to the timetable so that the deadline for the second written submission was set no earlier than 25 March 2016 (one week later than originally scheduled). The European Union commented on the United States' request on 7 January 2016. On 15 January 2016, the Panel informed the parties that it had declined the United States' request for an extension of the deadline for the second written submissions.^[8]

1.15.  In the course of the second meeting with the parties on 5 April 2016, the Panel informed the parties that in order to have sufficient time to assess the legal and factual issues in the dispute, the timetable would have to be adjusted so that the interim report was issued to parties on 15 June 2016 and all subsequent dates were similarly adjusted. The parties had no comments to this proposal. On 19 April 2016, the Panel issued the revised timetable.

1.16.  On 28 April 2016, the United States requested an opportunity to comment on certain factual evidence and arguments that were submitted by the European Union with its comments on the United States' responses to Panel questions. The European Union commented on the United States' request on 2 May 2016. On 4 May 2016, the Panel informed the parties that it had declined the United States' request.^[9]

1.17.  On 13 June 2016, the Panel informed the parties that it intended to issue the interim report to parties on 6 July 2016 and to adjust all subsequent dates similarly. The European Union submitted comments to this notice on 14 June. On 15 June 2016, the Panel issued a revised timetable.

1.18.  On 12 July 2016, the United States requested a two-day extension for parties to request the review of precise aspects of the interim report. On the same date, the European Union communicated its agreement to the United States' request, under the understanding that subsequent dates on the schedule would not change. On 13 July 2016, the Panel informed the parties that it had extended by two days the deadline for parties to request the review of precise aspects of the interim report, and that subsequent deadlines had not been revised. The Panel issued a revised timetable to the parties.

1.3.3  Additional Working Procedures for the Protection of Business Confidential Information (BCI) and Highly Sensitive Business Information (HSBI)

1.19.  At the request of the United States, and having considered comments from the European Union, the Panel adopted Additional Working Procedures for the Protection of Business Confidential Information and Highly Sensitive Business Information (BCI/HSBI Procedures) on 13 January 2016.^[10]

1.3.4  Additional Working Procedures for the Partial Opening to the Public of the Meetings of the Panel

1.20.  On 22 February 2016 and 23 March 2016, at the request of the United States, and noting the European Union's agreement, the Panel adopted additional working procedures for the partial opening to the public of the meetings of the Panel. These procedures provided for public viewing of a video-recording of non-confidential portions of each meeting by means of delayed broadcast. Closed sessions were foreseen for the parties to address BCI or HSBI and for those third parties that had requested not to make their statements in the video-recorded session for public viewing.^[11] The public screening of the video-recording of the non-confidential portions of the Panel meetings took place on 17 and 18 May 2016.

2  Factual aspects

2.1.  The claims brought by the European Union concern tax-related provisions for civil aircraft provided by the state of Washington in the United States, as amended by Engrossed Substitute Senate Bill 5952 (ESSB 5952), Chapter 2, Laws of 2013 3^rd Special Session, 2014 Wash. Sess. Laws 2. Specifically, this dispute concerns the following tax-related provisions contained in the Revised Code of Washington (RCW):

a.    a 0.2904% business and occupation tax rate with respect to the manufacture or sale of commercial airplanes, contained in RCW Section 82.04.260(11);

b.    tax credits for property taxes and leasehold excise taxes on commercial airplane manufacturing facilities, contained in RCW Section 82.04.4463;

c.    tax credits for aerospace product development, contained in RCW Section 82.04.4461;

d.    sales tax exemption for computer hardware, software, and peripherals, contained in RCW Section 82.08.975;

e.    sales tax exemption for construction services and materials, contained in RCW Section 82.08.980;

f.     use tax exemption for computer hardware, software, and peripherals, contained in RCW Section 82.12.975;

g.    use tax exemption for construction services and materials, contained in RCW Section 82.12.980;

h.    leasehold excise tax exemption, contained in RCW Section 82.29A.137; and

i.     leaseholder property tax exemption, contained in RCW Section 84.36.655.

2.2.  The European Union claims that the availability of the above tax incentives is subject to the conditions in Sections 2, 5, and 6 of ESSB 5952 (as codified at RCW Sections 82.32.850 and 82.04.260(11)(e)(ii)). These conditions relate to a decision on the initial siting of a "significant commercial airplane manufacturing program" (as defined in the relevant legislation^[12]) in the state of Washington, as well as to the future siting outside the state of Washington of "any final assembly or wing assembly of any version or variant of a commercial airplane that is the basis of a siting of a significant commercial airplane manufacturing program".^[13]

3  Parties' requests for findings and recommendations

3.1.  The European Union requests that the Panel find that each of the challenged Washington State tax incentives, as amended and extended by ESSB 5952, constitutes a subsidy that is prohibited pursuant to Articles 3.1(b) and 3.2 of the SCM Agreement due to being contingent on the use of domestic over imported goods. The European Union further requests, pursuant to Article 4.7 of the SCM Agreement, that the Panel recommend that the United States withdraw the subsidies without delay.

3.2.  The United States requests that the Panel reject the European Union's claims in this dispute and find that the challenged measures are not inconsistent with the United States' obligations under Articles 3.1(b) and 3.2 of the SCM Agreement.

4  Arguments of the parties

4.1.  The arguments of the parties are reflected in their executive summaries, provided to the Panel in accordance with paragraph 20 of the Working Procedures adopted by the Panel (see Annexes B-1, B-2, B-3, and B-4).

5  Arguments of the third parties

5.1.  The arguments of Australia, Brazil, Canada, China, and Japan are reflected in their executive summaries, provided in accordance with paragraph 21 of the Working Procedures adopted by the Panel (see Annexes C-1, C-2, C-3, C-4, and C-5). India, Korea, and Russia did not submit written or oral arguments to the Panel.

6  Interim review

6.1.  On 6 July 2016, the Panel issued its Interim Report to the parties. On 15 July 2016, the European Union and the United States each submitted written requests for review of precise aspects of the Interim Report. Neither party requested an interim review meeting. On 20 July 2016, each of the parties submitted comments on the other's requests for review.

6.2.  In accordance with Article 15.3 of the DSU, this section sets out the Panel's response to the parties' requests for review of precise aspects of the Report made at the interim review stage. The parties' requests for substantive modifications are discussed below, generally in sequence according to the paragraphs to which the requests pertain.

6.3.  The numbering of some of the paragraphs and footnotes in the Final Report has changed from the numbering in the Interim Report. The discussion below refers to the numbering in the Interim Report and, where it differs, includes the corresponding numbering in the Final Report.

6.4.  The United States notes that paragraph 7.4 summarizes the requests of the United States "but omits an issue raised by the United States for the Panel's consideration regarding the Panel's terms of reference". In particular, the United States requests inclusion of a reference to its opening statement at the first meeting of the Panel, in which the United States noted that, prior to the establishment of this Panel, the European Union had maintained that the measures at issue in this dispute were properly within the terms of reference of the compliance panel in the proceeding under Article 21.5 of the DSU in US – Large Civil Aircraft (2^nd complaint).^[14] The United States identifies paragraph 7.41 of the Interim Report (paragraph 7.39 of this Report) as "a logical place for the Panel to address the terms of reference issue identified by the United States".^[15] The European Union considers that this is an inappropriate request for review of an interim report and that it should be rejected by the Panel. The European Union requests that, to the extent that the Panel elects to include a discussion on the United States' statements related to terms of reference, the Panel reflect "the United States' repeated statements that it did not consider any of the measures to be outside the [Panel's] terms of reference".^[16] The Panel declines the United States' request for inclusion of a reference to this issue in the Panel's findings. In its statement to the Panel, the United States explicitly clarified that "the United States does not itself consider that any of the measures at issue are outside the Panel's terms of reference".^[17] Although the Panel recognizes that the vesting of jurisdiction is a fundamental issue that may need to be considered even in the absence of any objection by a party, the Panel does not find any reason to question the vesting of its jurisdiction in the present case. Moreover, apart from any potential relevance of statements by a party made in another dispute, it is an uncontested fact that the measures at issue in this dispute are not presently being considered in any other dispute. The Panel addresses the legislative background and scope of the measures within its terms of reference in Section 7.3.3, and does not consider any additional discussion of the issue raised by the United States to be necessary.

6.5.  The United States proposes an addition at the end of the second sentence of paragraph 7.7 to "elaborate the function of the Panel" in examining municipal law, which according to the United States is "to determine the proper factual predicate against which WTO-consistency will be judged".^[18] The European Union considers that the addition proposed by the United States is not necessary, as the current formulation is an accurate description of the existing jurisprudence on the matter.^[19] The United States also requests a revision to paragraph 7.8 to "avoid implying that an analysis of the meaning of a Member's municipal law could disregard the interpretive rules of a Member's domestic legal system".^[20] The European Union considers that the modification proposed by the United States is not necessary, as the current formulation is an accurate and succinct description of the existing jurisprudence relating to the identification of the meaning and content of domestic law.^[21] The Panel considers that paragraphs 7.7 and 7.8 adequately refer to Appellate Body reports and consequently does not consider the elaboration of the issue requested by the United States to be necessary.

6.6.  The European Union proposes to consolidate the discussions in paragraphs 7.7-7.8 and 7.15-7.16 on a panel's role in examining the meaning of municipal law.^[22] The United States recalls its comments on paragraphs 7.7-7.8 and requests that the Panel take those comments into account in making any modifications in response to the European Union's request.^[23] The Panel has consolidated this discussion to avoid duplication by deleting paragraphs 7.15 and 7.16 of the Interim Report.

6.7.  The European Union requests changes to paragraphs 7.17, 7.40, 7.81-7.84, and 7.245 of the Interim Report (paragraphs 7.15, 7.38, 7.79-7.82, and 7.243 of this Report), to "reflect the uncontested fact that the challenged aerospace tax incentives existed in Washington State prior to ESSB 5952, which amended the terms of those incentives".^[24] The United States has no objection to the revisions requested by the European Union.^[25] The Panel has revised the paragraphs identified by the European Union to refer to the measures "as amended and extended by" ESSB 5952.

6.8.  The United States requests revisions to paragraph 7.36 of the Interim Report (paragraph 7.34 of this Report) to reflect its view of the legislative history of the measures at issue in this dispute and the measures at issue in US – Large Civil Aircraft (2^nd complaint).^[26] The European Union requests that the Panel reject the United States' request for modification, which in its view "is predicated on a series of erroneous factual premises".^[27] In the light of the parties' comments, the Panel has made minor adjustments to the paragraph.

6.9.  Both the European Union and the United States suggest changes to paragraphs 7.39 and 7.42 of the Interim Report (paragraphs 7.37 and 7.40 of this Report) to provide a more accurate characterization of legislation in Washington State.^[28] The Panel has made consequential revisions to paragraphs 7.39 and 7.42 of the Interim Report in the light of the parties' comments.

6.10.  The United States requests the elimination of a sentence in paragraph 7.55 of the Interim Report (paragraph 7.53 of this Report), which states that an entitlement granted by virtue of the relevant legislation "could only be re-established through further legislation revoking or amending the previous legislation". The United States notes that "revoking or amending the particular legislation at issue are not the only alternatives" and revenue may no longer be foregone, for example, if the measure providing for the benchmark tax were changed.^[29] The European Union considers that the sentence, as currently worded, is correct.^[30] In the light of the parties' comments, the Panel has removed the word "only" from the sentence identified by the United States.

6.11.  The European Union requests in paragraphs 7.89, 7.104, 7.117, 7.113, 7.139, and 7.148 of the Interim Report (paragraphs 7.87, 7.102, 7.115, 7.131, 7.137, and 7.146 of this Report) the addition of a reference to the objectives of HB 2294 (along with the existing reference to ESSB 5952) in discussing the "objective reasons" for the relevant tax treatment of each aerospace tax measure.^[31] The United States does not agree with the European Union's request, and considers that it is unclear what relevance the European Union ascribes to the objectives of HB 2294 in the context of the relevant paragraphs. As part of its comments on the European Union's request, the United States requests a modification of paragraph 7.65 of the Interim Report (paragraph 7.63 of this Report), as legislation such as ESSB 5952 does not amend or extend previous legislation but rather amends or extends tax treatment provided for in the Revised Code of Washington, which itself reflects earlier legislation.^[32] The Panel does not consider the additional references requested by the European Union to be necessary. The paragraphs identified by the European Union clarify the "objective reasons" for each of the aerospace tax measures with supporting cross-references to the more extensive discussion in the context of the B&O aerospace tax rate, including reference to the objectives of prior legislation. The Panel has made the change requested by the United States in paragraph 7.63 of this Report.

6.12.  The United States requests a revision of the first sentence of paragraph 7.142 of the Interim Report (paragraph 7.140 of this Report) to reflect that, as noted in the remainder of the paragraph, the leasehold excise tax is an excise tax, and not a property tax.^[33] The European Union requests that the Panel reject the United States' proposed modification and retain the current language. In the European Union's view, the leasehold excise tax is functionally a property tax. To the extent that the United States wishes to clarify that the leasehold excise tax is not formally a "property tax" within the specific meaning of the Revised Code of Washington, the European Union considers that the Panel could replace the phrase "property tax" in the sentence at issue with the phrase "tax on property", when referring to the leasehold excise tax.^[34] The Panel has partially modified the first sentence of paragraph 7.142 of the Interim Report to accommodate the United States' request. However, the Panel has used the word "supplements" instead of "complements" (which was the word suggested by the United States) to describe the relationship of the "leasehold excise tax" to the "property taxes".

6.13.  The European Union requests in footnote 263 to paragraph 7.143 of the Interim Report (footnote 300 to paragraph 7.141 of this Report), in relation to the reference to the parties' arguments on the quantitative coverage of property tax exemptions, clarification of the cross-reference to the discussion of the parties' arguments concerning sales and use tax exemptions.^[35] The United States has no comment on the European Union's request.^[36] The Panel has made the requested clarification to footnote 263 of the Interim Report. The Panel has also provided a supplemental reference to the parties' arguments in a footnote to the last sentence of paragraph 7.121 of this Report.

6.14.  The European Union requests a revision of paragraph 7.176 of the Interim Report (paragraph 7.174 of this Report) to refer to "wing assembly", rather than "final assembly of a wing", in the description of its argument as to the potential triggering of the Second Siting Provision.^[37] The United States has no objection to the European Union's request.^[38] The Panel has made the requested correction to paragraph 7.176 of the Interim Report.

6.15.  The United States requests a revision of paragraph 7.187 of the Interim Report (paragraph 7.185 of this Report) to better capture the substance of the United States' argument in rejecting the European Union's interpretation of the word "use" in Article 3.1(b) of the SCM Agreement.^[39] The European Union makes no comment on the United States' request. The Panel has made the requested change.

6.16.  The European Union requests rephrasing paragraph 7.231 of the Interim Report (paragraph 7.229 of this Report), specifically by removing the word "challenged" before "aerospace tax measures", so as not to inaccurately convey that the measures challenged by the European Union are the aerospace tax incentives as they stood before the amendments and extensions effected by ESSB 5952.^[40] The United States agrees with the European Union's explanation and considers further that the first sentence in paragraph 7.231 of the Interim Report should be revised as explained in the United States' comments on paragraph 7.36 of the Interim Report discussed above.^[41] The Panel has made the modification requested by the European Union. The Panel has added a footnote to the first sentence of paragraph 7.229 of this Report referring to the earlier discussion of the legislative background of ESSB 5952, but declines to make the additional changes to the sentence requested by the United States.

6.17.  The European Union requests a change in paragraph 7.231 of the Interim Report of the phrase "the entry into force of the amended and extended aerospace tax measures was contingent" to instead state "the entry into force of the amendment and extension of the aerospace tax measures was contingent". According to the European Union, this change would clarify that it was only the amendment and extension of the tax measures that were conditional upon fulfilment of the First Siting Provision, rather than the entirety of the aerospace tax measures. The European Union requests similar changes to paragraphs 7.289 and 7.315(a) of the Interim Report to refer to the entry into force of the amendment and extension by ESSB 5952 of the aerospace tax measures.^[42] The United States has no objection to the European Union's requests.^[43] The Panel has made the requested modifications to paragraphs 7.231, 7.289, and 7.315(a) of the Interim Report (paragraphs 7.229, 7.287, and 7.313(a) of this Report).

6.18.  The European Union requests an additional citation in footnote 450 to paragraph 7.243 of the Interim Report (footnote 488 to paragraph 7.241 of this Report) to its submissions on the point that the measures at issue do not place any conditions on the use of elements or components of commercial airplanes, other than wings and fuselages.^[44] The United States has no objection to the European Union's request.^[45] The Panel has made the requested addition to the footnote.

6.19.  The European Union requests a modification of paragraph 7.289 of the Interim Report (paragraph 7.287 of this Report) to reflect that only wings or fuselages, not both, are required to be made of carbon fibre as noted elsewhere by the Panel.^[46] The United States has no objection to the European Union's request.^[47] The Panel has made the requested modification.

6.20.  The European Union requests inclusion in paragraph 7.352 of the Interim Report (paragraph 7.350 of this Report) of references to its submissions and exhibits that, in addition to evidence related to the 777X aircraft programme, "would support the more general proposition in relation to the aerospace industry" regarding the variety of aircraft manufacturing processes, as well as continuing innovation within the aerospace industry.^[48] The United States does not consider that adding the requested citations would provide additional clarity to the report, as they are not "illustrative for the purposes of the Panel's sentence".^[49] The Panel does consider them to be illustrative of the statements made in the paragraph and therefore has included the references identified by the European Union.

6.21.  The United States requests a revision of paragraph 7.358 of the Interim Report (paragraph 7.356 of this Report) as, in its view, the word "coincident" used in the paragraph "does not accurately capture the sequence of events" of Boeing's decision to site the 777X aircraft programme in Washington State. The United States also considers the same sentence "problematic in its reference to 'certain wing structures that the same manufacturer had previously imported for other commercial airplane manufacturing programmes'."^[50] The European Union requests that the Panel reject the United States' request for modification. In the European Union's view, the statement at issue is a "factual finding … based on an objective assessment of the evidence that the Parties placed before the Panel, and should not be rewritten based on the United States' own view of the evidence".^[51] In the light of the parties' comments, the Panel has made modifications and clarifications to the sentence in question.

6.22.  The European Union requests in paragraph 7.368 of the Interim Report (paragraph 7.366 of this Report) an adjustment of the left parenthesis in the phrase "(outside Washington State, including overseas)" as the current formulation "could potentially be misunderstood to indicate that the reference to Washington State is not an essential aspect of the explanation".^[52] The United States has no comment on the European Union's request.^[53] The Panel has made the requested modification.

6.23.  In addition to the requests discussed above, the Panel has made corrections for typographical and other non-substantive errors in the Interim Report, including those identified by the parties.

7  Findings

7.1  Introduction

7.1.  In this dispute, the European Union claims that the United States is acting inconsistently with the SCM Agreement by providing prohibited subsidies to the aerospace industry in the state of Washington. The European Union argues that these subsidies are provided by the state of Washington in the United States.

7.2.  More specifically, the European Union challenges seven aerospace tax measures^[54], namely: (i) a reduced business and occupation (B&O) tax rate for the manufacture and sale of commercial airplanes; (ii) a credit for the B&O tax for pre-production development of commercial airplanes and components; (iii) a credit for the B&O tax for property taxes on commercial airplane manufacturing facilities; (iv) an exemption from sales and use taxes for certain computer hardware, software, and peripherals; (v) an exemption from sales and use taxes for certain construction services and materials; (vi) an exemption from leasehold excise taxes on port district facilities used to manufacture superefficient airplanes; and (vii) an exemption from property taxes for the personal property of port district lessees used to manufacture superefficient airplanes.

7.3.  The European Union claims that the alleged subsidies are prohibited under Articles 3.1(b) and 3.2 of the SCM Agreement as subsidies that are contingent on the use of domestic over imported goods. According to the European Union this contingency results from two siting provisions – a First Siting Provision and a Second Siting Provision – contained in Engrossed Substitute Senate Bill 5952 (ESSB 5952). The European Union requests that the Panel recommend that the United States withdraw the subsidies without delay, on the basis that they are prohibited subsidies, as required by Article 4.7 of the SCM Agreement.

7.4.  The United States requests the Panel to find that the United States has acted consistently with its obligations under the SCM Agreement and to deny the relief requested by the European Union.

7.5.  This Report is organized as follows. Section 7.2 sets out the relevant principles regarding the Panel's function, the burden of proof, and treaty interpretation. Section 7.3 provides a description and background of the measures at issue. In section 7.4, the Panel examines whether the measures challenged by the European Union constitute subsidies within the meaning of Article 1 of the SCM Agreement. In section 7.5 the Panel turns to an examination of whether the challenged measures are prohibited under Article 3 of the SCM Agreement. The Panel sets forth its conclusions and recommendation in section 8.

7.2  Function of the Panel, Burden of Proof, and Treaty Interpretation

7.2.1  Function of the Panel

7.6.  According to Article 11 of the DSU:

The function of panels is to assist the DSB in discharging its responsibilities under this Understanding and the covered agreements. Accordingly, a panel should make an objective assessment of the matter before it, including an objective assessment of the facts of the case and the applicability of and conformity with the relevant covered agreements, and make such other findings as will assist the DSB in making the recommendations or in giving the rulings provided for in the covered agreements.

7.7.  The Panel has been required to examine municipal law in the course of exercising its functions under Article 11 of the DSU in this dispute. In this regard, the Appellate Body has explained that, "[a]lthough it is not the role of panels or the Appellate Body to interpret a Member's domestic legislation as such, it is permissible, indeed essential, to conduct a detailed examination of that legislation in assessing its consistency with WTO law".^[55] The Appellate Body has added that:

As part of their duties under Article 11 of the DSU, panels have the obligation to examine the meaning and content of the municipal law at issue in order to make an objective assessment of the matter before it, including an objective assessment of the facts of the case and the applicability and conformity with the covered agreements. This obligation under Article 11 means that panels must conduct their own objective and independent assessment of the meaning of municipal law, instead of deferring to a party's characterization of such law.^[56]

7.8.  In respect of the types and threshold of evidence that may be required to prove the WTO-inconsistency of municipal law, the Appellate Body has explained that "[i]f the meaning and content of the measure are clear on its face, then the consistency of the measure as such can be assessed on that basis alone. If, however, the meaning … is not evident on its face, further examination is required."^[57] The nature and the extent of the evidence required to satisfy the burden of proof will vary from case to case.^[58] In some cases, the text of the relevant legislation may be sufficient to clarify the content and the meaning of the relevant legal instruments. In other cases, the parties will also need to support their understanding of the content and meaning of such legal instruments with evidence beyond the text of the instrument, such as evidence of consistent application of such laws, pronouncements of domestic courts on the meaning of such laws, the opinions of legal experts, and the writings of recognized scholars.^[59] The task of a panel may be facilitated by agreement between the parties about the meaning of the law and its interpretation, being an interpretation that it is open for the panel to itself adopt. The Appellate Body has added that, "in ascertaining the meaning of municipal law, a panel should undertake a holistic assessment of all relevant elements, starting with the text of the law and including, but not limited to, relevant practices of administering agencies" as well as "legal interpretation[s] given by a domestic court or by a domestic administering agency as to the meaning of municipal law with respect to the measure being reviewed for consistency with the covered agreements".^[60]

7.2.2  Burden of proof

7.9.  The general rule in WTO dispute settlement is that the burden of proof rests upon the party, whether complaining or defending, who asserts the affirmative of a particular claim or defence.^[61] Following this principle, the Appellate Body has explained that the complaining party in any given dispute should establish a prima facie case of inconsistency of a measure with a provision of the WTO covered agreements, before the burden of showing consistency with that provision or defending it under an exception must be assumed by the defending party.^[62] In other words, "a party claiming a violation of a provision of the WTO Agreement by another Member must assert and prove its claim."^[63]

7.10.  A prima facie case is "one which, in the absence of effective refutation by the defending party, requires a panel, as a matter of law, to rule in favour of the complaining party presenting the prima facie case."^[64] To establish a prima facie case, the party asserting a particular claim must adduce evidence sufficient to raise a presumption that what is claimed is true. If the complaining party "adduces evidence sufficient to raise a presumption that what is claimed is true, the burden then shifts to the other party, who will fail unless it adduces sufficient evidence to rebut the presumption."^[65] In this regard, the Appellate Body has stated that:

[P]recisely how much and precisely what kind of evidence will be required to establish such … [presumptions] will necessarily vary from measure to measure, provision to provision, and case to case.^[66]

7.11.  The Appellate Body has also stated that "[a] complaining party may not simply submit evidence and expect the panel to divine from it a claim of WTO-inconsistency. Nor may a complaining party simply allege facts without relating them to its legal arguments".^[67]

7.12.  In this dispute, the European Union bears the burden of establishing a prima facie case that the disputed measures are prohibited subsidies inconsistent with Article 3 of the SCM Agreement. In addition, if the Panel finds that the European Union has made out its prima facie case, it is for the United States to provide rebuttal arguments and evidence that is needed to support that rebuttal.

7.2.3  Treaty interpretation

7.13.  Article 3.2 of the DSU provides that Members recognise that the dispute settlement system serves to clarify the provisions of the covered agreements "in accordance with customary rules of interpretation of public international law". It is well established that the principles codified in Articles 31 and 32 of the Vienna Convention on the Law of Treaties (the "Vienna Convention")^[68] are such customary rules of interpretation of public international law.^[69] They provide as follows:

ARTICLE 31
General rule of interpretation

1.    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.

2.    The context for the purpose of the interpretation of a treaty shall comprise, in addition to the text, including its preamble and annexes:

(a) any agreement relating to the treaty which was made between all the parties in connexion with the conclusion of the treaty;

(b) any instrument which was made by one or more parties in connexion with the conclusion of the treaty and accepted by the other parties as an instrument related to the treaty.

3.    There shall be taken into account together with the context:

(a) any subsequent agreement between the parties regarding the interpretation of the treaty or the application of its provisions;

(b) any subsequent practice in the application of the treaty which establishes the agreement of the parties regarding its interpretation;

(c) any relevant rules of international law applicable in the relations between the parties.

4.    A special meaning shall be given to a term if it is established that the parties so intended.

ARTICLE 32
Supplementary means of interpretation

Recourse may be had to supplementary means of interpretation, including the preparatory work of the treaty and the circumstances of its conclusion, in order to confirm the meaning resulting from the application of article 31, or to determine the meaning when the interpretation according to article 31:

(a) leaves the meaning ambiguous or obscure; or

(b) leads to a result which is manifestly absurd or unreasonable.

7.14.  There is a considerable body of WTO case law dealing with the application of these provisions. It is clear that interpretation must be based above all on the text of the treaty^[70], but that the context of the treaty also plays a role. It is also well-established that these principles of interpretation "neither require nor condone the imputation into a treaty of words that are not there or the importation into a treaty of concepts that were not intended."^[71] Furthermore, panels "must be guided by the rules of treaty interpretation set out in the Vienna Convention, and must not add to or diminish rights and obligations provided in the WTO Agreement."^[72]

7.3  Description and background of the measures at issue

7.3.1  Aerospace tax measures

7.15.  The European Union challenges seven separate tax measures for civil aircraft provided by the state of Washington (aerospace tax measures) as amended and extended by ESSB 5952^[73]:

(a)     reduced business and occupation (B&O) tax rate for the manufacture and sale of commercial airplanes (B&O aerospace tax rate)^[74];

(b)     B&O tax credit for pre-production development for commercial airplanes and components (B&O tax credit for aerospace product development)^[75];

(c)     B&O tax credit for property taxes on commercial airplane manufacturing facilities (B&O tax credit for property and leasehold excise taxes)^[76];

(d)     exemption from sales and use taxes for certain computer hardware, software, and peripherals (computer sales and use tax exemptions)^[77];

(e)     exemption from sales and use taxes for certain construction services and materials (construction sales and use tax exemptions)^[78];

(f)      exemption from leasehold excise taxes on port district facilities used to manufacture superefficient airplanes (leasehold excise tax exemption)^[79]; and

(g)     exemption from property taxes for the personal property of port district lessees used to manufacture superefficient airplanes (leaseholder property tax exemption)^[80].

7.16.  A person claiming the B&O tax credit for property and leasehold excise taxes, listed above as (c), is not eligible for either the leasehold excise tax exemption or the leaseholder property tax exemption, listed above as (f) and (g), respectively.

7.3.1.1  Measures related to the B&O tax

7.17.  The first three aerospace tax measures listed above pertain to the business and occupation (B&O) tax, which is the state of Washington's "major business tax"^[81], in that the state of Washington "relies primarily on a B&O tax – rather than a corporate tax or an income tax – for purposes of business taxation".^[82] The B&O tax is imposed "for the act or privilege of engaging in business activities" and "is measured by the application of rates against the value of products, gross proceeds of sales, or gross income of the business, as the case may be".^[83] The B&O tax applies to distinct business activities (such as retailing, manufacturing, wholesaling, extracting, and services). A business may have more than one B&O tax rate, depending on the types of activities conducted.^[84]

7.18.  The first tax measure above (B&O aerospace tax rate) provides for a B&O tax rate of 0.2904% for specified business activities.^[85] The other two B&O tax-related measures (B&O tax credits for aerospace product development and for property and leasehold excise taxes) provide credits against B&O tax liability based on specified expenditures or other tax payments made by the taxpayer concerned.^[86] The rules regarding the calculation of B&O tax liability for different types of activities as well as the amount of B&O tax credits are discussed below in connection with whether there is a financial contribution in the sense of Article 1 of the SCM Agreement.

7.3.1.2  Exemptions from sales and use taxes

7.19.  The next two aerospace tax measures in the above list are exemptions from the state of Washington's retail sales and use taxes. The retail sales tax is Washington State's principal source of tax revenue (including business and non-business tax revenue)^[87], and is collected from customers by businesses making retail sales in Washington State. The retail sales tax is generally imposed on the sale of tangible personal property^[88] and digital products^[89], as well as certain services^[90], to the final consumer or end user of such property, digital product, or service.^[91] The use tax is a tax on the use of goods or certain services in the state of Washington when sales tax has not been paid.^[92] Goods used in Washington State are subject to either sales or use tax, but not to both; thus, the use tax compensates when the sales tax has not been paid.^[93]

7.20.  The computer sales and use tax exemptions relate to sales or use "of computer hardware, computer peripherals, or software … used primarily in the development, design, and engineering of aerospace products or in providing aerospace services".^[94] These exemptions also relate to sales or use of "labor and services rendered in respect to installing the computer hardware, computer peripherals, or software".^[95]

7.21.  The construction sales and use tax exemptions concern labour, services, and personal property used to construct new buildings for the manufacture of commercial airplanes or the fuselages and wings of commercial airplanes. More specifically, the sales tax exemption applies to retail sales taxes on "[c]harges, for labor and services rendered in respect to the constructing of new buildings, made to a manufacturer engaged in the manufacturing of commercial airplanes or the fuselages or wings of commercial airplanes".^[96] Sales and use tax exemptions apply to the sales and use of "tangible personal property that will be incorporated as an ingredient or component"^[97] in constructing such buildings. These construction sales and use tax exemptions also apply to charges for construction labour and services made to, and tangible personal property used in constructing new buildings for, "a port district, political subdivision, or municipal corporation, to be leased to a manufacturer engaged in the manufacturing of commercial airplanes or the fuselages or wings of commercial airplanes".^[98]

7.22.  The applicable tax rates and coverage of retail sales and use taxes in Washington State are considered in greater detail below in connection with whether these exemptions constitute a financial contribution in the sense of Article 1 of the SCM Agreement.

7.3.1.3  Exemptions from taxes imposed on certain leaseholds

7.23.  The final two aerospace tax measures concern property taxes imposed on certain leaseholds in Washington State. Real and personal property in Washington State is generally subject to property taxes based on its value, unless a specific exemption is provided by law.^[99] For example, all property owned by federal, state, and local governments is exempt from the Washington State property tax.^[100]

7.24.  The leasehold excise tax exemption relates to the Washington State leasehold excise tax, which is imposed in lieu of a property tax on the use of public property by a private party.^[101] More specifically, Washington State imposes "a leasehold excise tax on the act or privilege of occupying or using publicly owned real or personal property … through a leasehold interest".^[102] The leasehold excise tax exemption applies to "[a]ll leasehold interests in port district facilities exempt from tax under [the construction sales and use tax exemptions] and used by a manufacturer engaged in the manufacturing of superefficient airplanes".^[103]

7.25.  Under the leaseholder property tax exemption, Washington State also exempts from property taxation "all buildings, machinery, equipment, and other personal property of a lessee of a port district eligible [for the construction sales and use tax exemptions], used exclusively in manufacturing superefficient airplanes".^[104]

7.26.  Neither the leasehold excise tax exemption nor the leaseholder property tax exemption is available to a person claiming the B&O tax credit for property and leasehold excise taxes.^[105]

7.3.2  Siting provisions

7.27.  The European Union identifies two "siting" provisions that govern the availability of the above aerospace tax measures, namely a First Siting Provision^[106] relating to all of the aerospace tax measures, and a Second Siting Provision^[107] relating only to the B&O aerospace tax rate.^[108]

7.3.2.1  First Siting Provision

7.28.  Each of the above aerospace tax measures is extended, and certain others are also amended, by ESSB 5952, which, according to the First Siting Provision in Section 2 of ESSB 5952, "takes effect contingent upon the siting of a significant commercial airplane manufacturing program in the state of Washington". Alternatively, "[i]f a significant commercial airplane manufacturing program is not sited in the state of Washington by June 30, 2017, … [this act] does not take effect".^[109]

7.29.  The First Siting Provision defines "siting" to mean "a final decision, made on or after November 1, 2013, by a manufacturer to locate a significant commercial airplane manufacturing program in Washington State". In turn, "significant commercial airplane manufacturing program" is defined as:

[A]n airplane program in which the following products, including final assembly, will commence manufacture at a new or existing location within Washington state on or after the effective date of this section:

(i) The new model, or any version or variant of an existing model, of a commercial airplane; and

(ii) Fuselages and wings of a new model, or any version or variant of an existing model, of a commercial airplane.^[110]

7.30.  The First Siting Provision additionally defines "new model, or any version or variant of an existing model, of a commercial airplane" to mean "a commercial airplane manufactured with a carbon fiber composite fuselage or carbon fiber composite wings or both".^[111]

7.31.  Both parties agree that the First Siting Provision has been fulfilled and, as a result, the measures set out in ESSB 5952 are in effect.^[112]

7.3.2.2  Second Siting Provision

7.32.  ESSB 5952 also contains a Second Siting Provision, relating only to the B&O aerospace tax rate^[113], which provides as follows:

With respect to the manufacturing of commercial airplanes or making sales, at retail or wholesale, of commercial airplanes, this subsection (11) [i.e. the B&O aerospace tax rate] does not apply on and after July 1st of the year in which the department [i.e. the Department of Revenue] makes a determination that any final assembly or wing assembly of any version or variant of a commercial airplane that is the basis of a siting of a significant commercial airplane manufacturing program in the state under section 2 of this act [i.e. the First Siting Provision] has been sited outside the state of Washington. This subsection (11)(e)(ii) [i.e. the Second Siting Provision] only applies to the manufacturing or sale of commercial airplanes that are the basis of a siting of a significant commercial airplane manufacturing program in the state under section 2 of this act.

7.33.  The Second Siting Provision thus concerns the continued availability of the B&O aerospace tax rate for the version or variant of the commercial airplane that is the basis of the First Siting Provision. The Second Siting Provision specifically pertains to the siting of "any final assembly or wing assembly" of that commercial airplane. As agreed by the parties, and as explained more fully below, the Boeing 777X is the relevant version or variant of commercial airplane that served as the basis for fulfilment of the First Siting Provision.^[114]

7.3.3  Legislative background and scope of the measures at issue

7.34.  ESSB 5952 amends and extends certain tax measures established in 2003 under Washington State Legislature House Bill 2294 (HB 2294)^[115], which were measures at issue in the dispute US – Large Civil Aircraft (2^nd complaint).^[116]

7.35.  The parties have raised different views as to the temporal scope of the measures at issue and the applicability of the contingencies introduced by ESSB 5952. For example, with reference to pre-existing tax measures in Washington State, the United States submits that "[a]bsent ESSB 5952, aerospace activity through 2024 subject to the B&O tax, the sales and use tax, the property excise tax, and the leasehold excise tax would have qualified under HB 2294 and for the [aerospace tax measures] identified by the European Union", and thus contends that "the treatment prior to 2024 under any of these measures, even if the measure were determined to be a subsidy, is a priori not contingent on any conditions introduced by ESSB 5952".^[117] By contrast, the European Union asserts that its challenge is not limited to the extended tax treatment from 2024 to 2040 effected by ESSB 5952, but rather that "the European Union is challenging the subsidies at issue from the point in time that they became contingent on satisfaction of the [First Siting Provision] conditions in SSB 5952, i.e., November 2013. The European Union challenges the existence of a financial contribution for the whole period from November 2013 through June 2040."^[118]

7.36.  In light of these differing assertions, the Panel first reviews the legislative background and scope of the measures at issue before turning to the claims raised in this dispute. The tax measures adopted by the Washington State Legislature in 2003 under HB 2294 included a reduction in the B&O tax rate^[119]; a B&O tax credit for pre-production development expenditures^[120]; a B&O tax credit for computer software and hardware^[121]; and a B&O tax credit for property taxes paid on property used in the manufacture of commercial airplanes and airplane components.^[122] Also included were sales and use tax exemptions for computer equipment and software, and their installation, as well as construction services and equipment, used primarily in the development of commercial airplanes and components.^[123] A leasehold excise tax exemption and property tax exemption for port district facilities was also available to manufacturers of superefficient airplanes that were not using the B&O tax credit for property taxes.^[124] These measures were scheduled to end in 2024.^[125]

7.37.  ESSB 5952 extended the availability of these tax measures to 2040 upon fulfilment of the First Siting Provision through the siting of the Boeing 777X programme. ESSB 5952 also provided that the B&O aerospace tax rate would no longer apply to that programme if the conditions foreseen in the Second Siting Provision occurred. At the same time, the aerospace tax measures reflect substantive amendments made by ESSB 5952 as well as other legislative changes made to the tax measures in the intervening period between HB 2294 and ESSB 5952. For example, with regard to the B&O aerospace tax rate, in 2006, Washington State Legislature House Bill 2466 (HB 2466) also extended the reduced B&O tax rate to certain certified repair stations^[126], and consolidated the B&O aerospace tax rates for the manufacture of commercial airplanes and components, and for the sales of commercial airplanes and components, into a single provision covering both manufacture and sales.^[127] In addition, Substitute Senate Bill 6828 (SSB 6828) of 2008 extended the reduced B&O tax rate to the manufacture and retailing of tooling used in the manufacture of commercial airplanes and components of airplanes.^[128] The B&O tax credit for aerospace product development reflects an extension of the credit to non-manufacturing firms under HB 2466 of 2006.^[129] It further reflects the extension under SSB 6828 of the credit for preproduction development to "aerospace product development", which was subsequently carried over in the provisions extended by ESSB 5952.^[130] The B&O tax credit for property and leasehold excise taxes amended by ESSB 5952 reflects the prior 2006 amendment under HB 2466 to include leasehold excise taxes in addition to property taxes as part of this B&O tax credit.^[131] The computer sales and use tax exemptions amended by ESSB 5952 reflect prior changes made under HB 2466 of 2006 and under SSB 6828 of 2008.^[132] Further, ESSB 5952 amends the construction sales and use tax exemptions originally established in HB 2294 by changing their application to "the manufacturing of commercial airplanes or the fuselages and wings of commercial airplanes" rather than to "manufacturing of superefficient airplanes".^[133]

7.38.  ESSB 5952 was enacted in November 2013 by the Washington State legislature. Pursuant to the First Siting Provision, the aerospace tax measures, as amended and extended by ESSB 5952, were to take effect upon the determination by the Department of Revenue of Washington State that the First Siting Provision had been satisfied, based on the "siting" of a "significant commercial airplane manufacturing program" as defined in that provision. On 9 July 2014, Boeing submitted a letter to the Department of Revenue of Washington State providing formal notification that Boeing had made a final decision to manufacture the 777X in Washington State, and describing how the 777X satisfied the requirements of the First Siting Provision.^[134] The Department of Revenue of Washington State provided written notice on 10 July 2014 of its determination that the First Siting Provision had been fulfilled and that ESSB 5952 had taken effect on 9 July 2014.^[135] The Boeing 777X was the model of commercial airplane that served as the basis for determining that the First Siting Provision had been fulfilled.^[136]

7.39.  For the purposes of this dispute, the measures that are within the Panel's terms of reference are those identified by the European Union in its request for the establishment of a panel.^[137] These measures are the aerospace tax measures, as presently codified in the RCW provisions cited in the European Union's panel request.^[138] The aerospace tax measures as codified^[139] reflect the substantive amendments made under ESSB 5952 as well as other legislative amendments subsequent to the enactment of HB 2294 in 2003, and are presently in effect until 2040. The aerospace tax measures are further subject to the First and Second Siting Provisions, which were introduced by ESSB 5952.

7.40.  Recalling the parties' different views as to the temporal scope of the measures at issue and the applicability of the contingencies introduced by ESSB 5952, the Panel considers that the measures at issue are not limited to tax treatment for the period of extension from 2024 to 2040. Rather, given the Panel's terms of reference as well as the various substantive amendments effected by ESSB 5952 and prior to its passage, the aerospace tax measures and Siting Provisions at issue are those that are in effect pursuant to codified provisions of Washington State law following the enactment and entry into force of ESSB 5952.

7.4  Existence of a subsidy under Article 1 of the SCM Agreement

7.4.1  Arguments of the parties

7.41.  The European Union contends that the aerospace tax measures are subsidies within the meaning of Article 1 of the SCM Agreement.^[140] According to the European Union, each of the aerospace tax measures at issue constitutes a financial contribution under Article 1.1(a)(1)(ii) of the SCM Agreement because "government revenue that is otherwise due is foregone or not collected". In support of its contention, the European Union proposes various benchmarks for comparison for the aerospace tax measures and contends that, in relation to these benchmarks, government revenue that would otherwise be due is foregone. The European Union also draws upon findings in US – Large Civil Aircraft (2^nd complaint) and contends that similar considerations apply in respect of measures that are analogous to those that were found to constitute financial contributions in that dispute. At the same time, the European Union distinguishes its claim from that made in US – Large Civil Aircraft (2^nd complaint) as it argues in the present case "that a financial contribution exists in the abstract" rather than being entity-specific.^[141] The European Union contends that government revenue does not need to have been actually foregone for there to be a financial contribution, but rather that it is the foregoing of the government's entitlement to collect revenue that is determinative of a financial contribution.^[142] Further, the European Union argues that the conferral of a benefit is a natural consequence of the foregoing of government revenue in comparison to "market" conditions.^[143]

7.42.  The United States asserts that the European Union fails to make a prima facie case that any of the challenged measures constitutes a financial contribution. The United States also disputes the European Union's reliance on findings made in respect of contested measures in US – Large Civil Aircraft (2^nd complaint) to demonstrate a financial contribution in this dispute.^[144] While acknowledging the European Union's clarification as to a financial contribution existing "in the abstract", the United States contends that the present tense drafting of Article 1.1(a)(ii) means that "this provision covers revenue foregone or not collected in the present".^[145] In addition, the United States disagrees with various legal interpretations advanced by the European Union, including that the term "maintain" in Article 3.2 refers to the continuation of a subsidy that has been "granted"^[146], as well as the European Union's distinction between the terms "not collected" and "foregone", arguing that both are in the present passive tense, and that "the two verbs describe different ways that the government may obtain tax income".^[147] With respect to the benefit allegedly conferred, the United States agrees with the European Union that "the concept of financial contribution in the form of revenue foregone that is otherwise due often overlaps with the concept of benefit", but contends that "[t]he European Union has not identified with sufficient clarity what the benefit is that it is alleging, much less provided evidence that the two concepts fully overlap in the present case."^[148] The United States further contends that the European Union erroneously argues that a finding of benefit proceeds automatically from a finding that revenue is foregone.^[149]

7.4.2  Third-party views

7.43.  Australia submits "that by the very nature of the type of transaction relating to the foregoing or non-collection of government revenue, the actual use or exercise of the fiscal incentive by a beneficiary/recipient may not necessarily be determinative in establishing the existence of a financial contribution".^[150] Accordingly, Australia frames the question as "whether, but for the tax incentive, the beneficiary of the tax measure would owe revenue payable as a debt, but expect it to be forgone or not collected".^[151] With regard to the benefit conferred, Australia refers to the standard of a measure making a recipient "better off" in comparison to the marketplace, and that, "[i]n this instance, the marketplace would be made up of other companies facing the usual tax rates set by Washington State, without provision of the discounts offered to companies that qualified for the tax exemption/discount".^[152]

7.4.3  Whether there is a financial contribution as "government revenue that is otherwise due is foregone or not collected"

7.44.  Article 1.1(a)(1)(ii) 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 … , i.e. where:

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

7.45.  With regard to the legal standard under Article 1.1(a)(1)(ii) of the SCM Agreement, the Appellate Body has set out the following considerations:

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".^[153] (emphasis original)

7.46.  The Appellate Body therefore considered that "the term 'otherwise due' implies some kind of comparison between the revenues due under the contested measure and revenues that would be due in some other situation", and that "the basis of comparison must be the tax rules applied by the Member in question".^[154] The Appellate Body further stated that, "[i]n identifying the appropriate benchmark for comparison, panels must obviously ensure that they identify and examine fiscal situations which it is legitimate to compare. In other words, there must be a rational basis for comparing the fiscal treatment of the income subject to the contested measure and the fiscal treatment of certain other income."^[155]

7.47.  The Appellate Body considered that there may be situations where the measures at issue might be described as an "exception" to a general rule of taxation, and that in such situations it may be possible to apply a "but for" test to examine the fiscal treatment of income absent the contested measure. At the same time, given the variety and complexity of domestic tax systems, the Appellate Body did not consider that "Article 1.1(a)(1)(ii) always requires panels to identify, with respect to any particular income, the 'general' rule of taxation prevailing in a Member".^[156] Instead, the Appellate Body explained "that panels should seek to compare the fiscal treatment of legitimately comparable income to determine whether the contested measure involves the foregoing of revenue which is 'otherwise due', in relation to the income in question".^[157]

7.48.  In US – Large Civil Aircraft (2^nd complaint), the Appellate Body reiterated the principle that it is necessary to identify "legitimately comparable" situations of taxation in order to determine whether government revenue is foregone.^[158] The Appellate Body further articulated three analytical steps for a panel examining a claim under Article 1.1(a)(1)(ii) of the SCM Agreement.

7.49.  First, a panel should "identify the tax treatment that applies to the income of the alleged recipients", which "will entail consideration of the objective reasons behind that treatment and, where it involves a change in a Member's tax rules, an assessment of the reasons underlying that change".^[159]

7.50.  Second, "the panel should identify a benchmark for comparison – that is, the tax treatment of comparable income of comparably situated taxpayers", which "involves an examination of the structure of the domestic tax regime and its organizing principles".^[160] The Appellate Body noted the potential difficulty of this exercise given that such principles may "be unique to the particular domestic regime" or "that disparate tax measures, implemented over time, do not easily offer up coherent principles serving as a benchmark".^[161] Nevertheless, "the task of the panel is to develop an understanding of the tax structure and principles that best explains that Member's tax regime, and to provide a reasoned basis for identifying what constitutes comparable income of comparably situated taxpayers".^[162]

7.51.  Third, "the panel should compare the reasons for the challenged tax treatment with the benchmark tax treatment it has identified after scrutinizing a Member's tax regime".^[163] According to the Appellate Body, this "comparison will enable a panel to determine whether, in the light of the treatment of the comparable income of comparably situated taxpayers, the government is foregoing revenue that is otherwise due in relation to the income of the alleged recipients."^[164]

7.52.  Before proceeding to the analysis of each aerospace tax measure under Article 1.1(a)(1)(ii) of the SCM Agreement, the Panel will address the United States' argument that aerospace activity until 1 July 2024 would have qualified for certain tax treatment under legislation pre-dating ESSB 5952, and that the extent of any financial contribution in this dispute would be limited to revenue foregone at some point in the future.^[165] The Panel recalls that the European Union has argued that, unlike in a past dispute under another provision of the SCM Agreement, in this case the European Union is advancing its claim in the abstract, on the basis of the pertinent legislation as such, and that it considers that Article 1.1(a)(1)(ii) covers not only the foregoing of actual revenue in the present, but also the foregoing of an entitlement to future revenue.^[166]

7.53.  In respect of the measures at issue, the Panel agrees with the European Union that Article 1.1(a)(1)(ii) of the SCM Agreement encompasses the foregoing of revenue in the future.^[167] In the particular context of tax-based measures, the underlying legislation may be effective over a period defined in the legislation itself, or indefinitely. Where such legislation gives rise to a financial contribution in the form of revenue foregone, the fact of a government having forgone such revenue is true for the entire period during which the legislation is in force. Even if the effective start date of a period defined in the legislation is subsequent to the date on which the legislation enters into force, as of the date of entry into force the government would have, by virtue of the legislation, already given up its entitlement to the future tax revenue during the defined future period.^[168] That entitlement could be re-established through further legislation revoking or amending the previous legislation. This principle is implicit in past cases involving financial contributions from tax-based measures. Where the rulings in those cases have been based on the underlying legislation as such, they have not only concerned particular revenue streams foregone in particular periods, but instead have concerned all of the implicit future revenue streams that would be foregone pursuant to the underlying legislation.^[169]

7.54.  In this connection, the present tense of the verb "is" in Article 1.1(a)(1)(ii) relates to a government presently foregoing an entitlement to collect revenue either now or in the future.^[170] It is this government action taken with respect to otherwise applicable tax liabilities that is the focus of the analysis under Article 1.1(a)(1)(ii), particularly where the measures are challenged as such rather than "against the application … during any given point in time or in any specific instance".^[171] In this dispute, the Panel has determined that the aerospace tax measures at issue are those that are presently in effect pursuant to codified provisions of Washington State law following the enactment and entry into force of ESSB 5952.^[172] A finding that the aerospace tax measures result in government revenue being foregone, or that they cause government revenue to be foregone, be it currently or in the future, applies to the measures themselves. This foregoing of revenue would apply to taxpayers at any time during the entire period in which the measures are in force. The foregoing of revenue is constituted by the government's promise to do so, and not only by particular instances of it being done.

7.55.  Having addressed the threshold issue of revenue foregone in the future, the Panel now examines each of the challenged aerospace tax measures, as such, on the basis of the analytical framework outlined above, to assess whether any of them involves a financial contribution in the form of government revenue foregone within the meaning of Article 1.1(a)(1)(ii) of the SCM Agreement.

7.4.3.1  B&O aerospace tax rate

7.56.  The legislation for the B&O aerospace tax rate provides in relevant part:

(11)(a) Beginning October 1, 2005, upon every person engaging within this state in the business of manufacturing commercial airplanes, or components of such airplanes, or making sales, at retail or wholesale, of commercial airplanes or components of such airplanes, manufactured by the seller, as to such persons the amount of tax with respect to such business is, in the case of manufacturers, equal to the value of the product manufactured and the gross proceeds of sales of the product manufactured, or in the case of processors for hire, equal to the gross income of the business, multiplied by the rate of:

(i) 0.4235 percent from October 1, 2005, through June 30, 2007; and

(ii) 0.2904 percent beginning July 1, 2007.

(b) Beginning July 1, 2008, upon every person who is not eligible to report under the provisions of (a) of this subsection (11) and is engaging within this state in the business of manufacturing tooling specifically designed for use in manufacturing commercial airplanes or components of such airplanes, or making sales, at retail or wholesale, of such tooling manufactured by the seller, as to such persons the amount of tax with respect to such business is, in the case of manufacturers, equal to the value of the product manufactured and the gross proceeds of sales of the product manufactured, or in the case of processors for hire, be equal to the gross income of the business, multiplied by the rate of 0.2904 percent.^[173]

7.4.3.1.1  First step: applicable tax treatment

7.57.  Based on the available evidence, the Panel will first identify the applicable tax treatment under the B&O aerospace tax rate, including consideration of the objective reasons behind that treatment. As provided for in the relevant legislation, the B&O aerospace tax rate applies to "every person engaging within [the state of Washington] in the business of manufacturing commercial airplanes, or components of such airplanes, or making sales, at retail or wholesale, of commercial airplanes or components of such airplanes, manufactured by the seller".^[174] The B&O aerospace tax rate also applies to those persons "engaging within [the state of Washington] in the business of manufacturing tooling specifically designed for use in manufacturing commercial airplanes or components of such airplanes, or making sales, at retail or wholesale, of such tooling manufactured by the seller".^[175]

7.58.  Thus, the B&O aerospace tax rate applies to the following activities within the state of Washington: (i) the manufacture of commercial airplanes (and components thereof); (ii) sales of commercial airplanes (and components thereof) by such manufacturers; and (iii) the manufacture and sales of tooling for use in manufacturing commercial airplanes or components of such airplanes.

7.59.  The B&O aerospace tax rate is a specific rate of taxation applicable to these activities. For the manufacture and sales of commercial airplanes and components thereof, this specific rate was implemented in two stages: first, a rate of 0.4235% from 1 October 2005 through 30 June 2007; and second, a rate of 0.2904% beginning 1 July 2007.^[176] For the manufacture and sales of tooling for use in manufacturing commercial airplanes or components of such airplanes, the applicable rate as of 1 July 2008 is 0.2904%. As a result of the enactment of ESSB 5952, the B&O aerospace tax rate expires on 1 July 2040.^[177]

7.60.  Thus, the relevant tax treatment at present and until the expiration of the B&O aerospace tax rate in 2040 is the tax rate of 0.2904%. This rate is multiplied by, "in the case of manufacturers … the value of the product manufactured and the gross proceeds of sales of the product manufactured, or in the case of processors for hire … the gross income of the business".^[178]

7.61.  With regard to the "objective reasons" behind this tax treatment^[179], the Panel notes that the underlying legislation itself repeatedly refers to tax "incentives" and "preferences" to encourage the aerospace industry (as such) to remain in Washington State and to expand its presence there. For instance, ESSB 5952 is entitled "Aerospace Industry – Tax Preferences – Tax Exemption".^[180] The published Session Laws of Washington State containing ESSB 5952 characterize the act as "[r]elating to incentivizing a long term commitment to maintain and grow jobs in the aerospace industry in Washington state by extending the expiration date of aerospace tax preferences".^[181]

7.62.  In the text of the legislation itself, the Washington State legislature explicitly set out the reasons for enacting the aerospace tax measures in ESSB 5952:

The legislature finds that the people of Washington have benefited enormously from the presence of the aerospace industry in Washington state. The legislature further finds that the industry continues to provide good wages and benefits for the thousands of engineers, mechanics, and support staff working directly in the industry throughout the state. The legislature further finds that suppliers and vendors that support the aerospace industry in turn provide a range of well-paying jobs. In 2003, and again in 2006, and 2007, the legislature determined it was in the public interest to encourage the continued presence of the aerospace industry through the provision of tax incentives. To this end, and in recognition of the continuing extreme importance of the aerospace industry in Washington, it is the legislature's intent to reaffirm and build upon prior aerospace tax incentive legislation in a fiscally prudent manner.

…

It is the legislature's specific public policy objective to maintain and grow Washington's aerospace industry workforce. To help achieve this public policy objective, it is the legislature's intent to conditionally extend aerospace industry tax preferences until July 1, 2040, in recognition of intent by the state's aerospace industry sector to maintain and grow its workforce within the state.^[182]

7.63.  These references make clear that the purpose of the legislation is to provide favourable tax treatment for the aerospace industry, in order to encourage the industry to remain in Washington State and to grow its workforce. As stated in the Final Bill Report of ESSB 5952, "[t]he explicitly described public policy objective of the act is to maintain and grow Washington [State]'s aerospace industry workforce."^[183] This language is similar to that of the prior legislation in HB 2294. In HB 2294 the Washington State legislature "declare[d] that it is in the public interest to encourage the continued presence of [the aerospace] industry through the provision of tax incentives. The comprehensive tax incentives in this act address the cost of doing business in Washington state compared to locations in other states."^[184] The mechanism for achieving the objective of encouraging the aerospace industry is, in the words of both pieces of legislation, the provision of tax "preferences", "exemptions", and "incentives".

7.4.3.1.2  Second step: benchmark for comparison

7.64.  Having identified the relevant tax treatment and its objective reasons, the next step of this analysis is the identification of an appropriate "benchmark for comparison" within the Washington State tax regime to determine whether this tax treatment constitutes revenue foregone by the Washington State government that would otherwise be due. This benchmark must be ascertained with regard for "the structure of the domestic tax regime and its organizing principles".^[185]

7.65.  The European Union submits that the benchmarks for comparison are the "general B&O tax rate for manufacturing and wholesaling activities" of 0.484% and that of 0.471% otherwise applicable to retailing.^[186] The United States generally contends that the European Union has not met its burden to identify the benchmark for each aerospace tax measure. With specific respect to the B&O aerospace tax rate, the United States submits that Washington State's unique B&O tax system results in a pyramiding effect and thus "the industry in which a taxpayer sits may impact whether it is comparably situated to a taxpayer in the aerospace industry".^[187] The United States also submits that "there is no question that Boeing's 777X program would have qualified for the 0.2904 percent B&O tax rate established under HB 2294 through 2024 if Washington had not enacted ESSB 5952", and contends on this basis that "[Boeing's] eligibility for that rate during the 2014-2024 does not represent revenue foregone".^[188]

7.66.  As a threshold matter, the Panel notes that the parties' arguments on the benchmark for examining the B&O aerospace tax rate relate specifically to the B&O tax regime, as distinguished from other types of taxation that exist in Washington State. Given that the B&O tax is the primary business tax in Washington State, and noting the parties' argumentation based on particular features of that regime, the Panel frames its assessment of "legitimately comparable" tax situations in the light of the specific structure and organizing principles of the B&O tax regime.

7.67.  The Washington State B&O tax is imposed "for the act or privilege of engaging in business activities" and "is measured by the application of rates against the value of products, gross proceeds of sales, or gross income of the business, as the case may be".^[189] In general, the B&O tax rate varies by activity, according to the following "major B&O tax classifications": (i) manufacturing; (ii) wholesaling; (iii) retailing; and (iv) services and other activities.^[190]

7.68.  Because the B&O aerospace tax rate applies to manufacturing, wholesaling, and retailing activities for commercial airplanes (as well as their components and tooling), these are the B&O tax classifications that are pertinent to the benchmark for comparison. The provisions of Washington State law governing these three categories of B&O tax are set out below:

Manufacturing: Upon every person engaging within this state in business as a manufacturer, except persons taxable as manufacturers under other provisions of this chapter; as to such persons the amount of the tax with respect to such business shall be equal to the value of the products, including byproducts, manufactured, multiplied by the rate of 0.484 percent.^[191] (emphasis added)

Wholesale: Upon every person engaging within this state in the business of making sales at wholesale, except persons taxable as wholesalers under other provisions of this chapter; as to such persons the amount of tax with respect to such business shall be equal to the gross proceeds of sales of such business multiplied by the rate of 0.484 percent.^[192] (emphasis added)

Retail: Upon every person engaging within this state in the business of making sales at retail, except persons taxable as retailers under other provisions of this chapter, as to such persons, the amount of tax with respect to such business is equal to the gross proceeds of sales of the business, multiplied by the rate of 0.471 percent.^[193] (emphasis added)

7.69.  The Panel considers that these general rates, as set out in these provisions and identified by the European Union, properly serve as the "normative benchmark"^[194] for comparison within the Washington State B&O tax system. The express wording of the relevant statutes contemplates a general rate of B&O taxation applicable to "every person" engaging in the relevant activity, "except" where such persons are taxable "under other provisions" of the same chapter.

7.70.  Moreover, other documents produced by Washington State addressing the B&O aerospace tax rate support the understanding that, in the absence of an explicit provision for a different tax treatment, B&O taxation would generally operate according to these major activity classifications and the corresponding rates of taxation. The Final Bill Report to ESSB 5952 describes the B&O tax and explains that "[m]ajor tax rates are 0.471 per cent for retailing; 0.484 per cent for manufacturing, wholesaling, and extracting; and 1.5 per cent for services, and activities not classified elsewhere".^[195] The Department of Revenue Fiscal Note in relation to ESSB 5952 provides a "narrative explanation" of the measures having a fiscal impact, which refers to "[r]educed business and occupation (B&O) tax rates of 0.2904% for manufacturers of commercial airplanes (instead of the general manufacturing rate of 0.484%)".^[196] Further, the Washington State Administrative Code refers to the RCW Section containing the B&O aerospace tax rate as "provid[ing] several special B&O tax rates/classifications for manufacturers engaging in certain manufacturing activities".^[197] Finally, a 2016 Tax Exemption Study by the Washington State Department of Revenue characterizes the B&O aerospace tax rate as a "preferential rate".^[198]