Research on the provisions of the concept of direct fund transfer of the SCM Agreement

Article 1.1(a)(1) of the WTO Agreement on Subsidies and Countervailing Measures (SCM) provides that a subsidy in international trade exists if:

- There is a financial contribution by a government or a public entity in the territory of a Member (hereinafter referred to in this Agreement as “the government”) when:

(i) The government practice involves actual direct transfers of funds (e.g. grants, loans, or equity infusions), potential direct transfers of funds or liabilities (e.g. loan guarantees);.....

The following study will focus on analyzing the concept of “direct transfer of funds” and some related concepts according to the conclusions of the WTO Dispute Settlement Body in related cases.

1. Government Acts

The term “government” includes both “government” and “public bodies”, so the phrase “government act” refers to the act of both governments and public bodies, and therefore does not necessarily have a narrow meaning that refers to acts such as regulation or taxation. The phrase “government act” is used to denote the person performing the act, rather than the nature of the act, and therefore “government act” includes all acts of governments or public bodies, whether or not they involve the exercise of regulatory or taxing powers”.[1]

2. “Direct transfer of funds”

The term “direct transfer of funds” refers to “government acts in which money, financial resources and/or financial claims are provided to recipients”[2]. The meaning of “funds” includes not only money, but also financial resources and other financial claims in general[3]. “… direct transfers of funds will normally involve the government providing finance to the recipient. In some cases, such as grants, the transfer of funds will not involve a reciprocal obligation on the part of the recipient. In other cases, such as loans and capital injections, the recipient has an obligation to the government in return for the funds provided. The provision of funds may therefore be equivalent to a donation or may involve reciprocal rights and obligations”[4].

In addition, although some of the disbursements envisaged under the relevant contracts have not yet been implemented, it can still be concluded that the measures concerned fall within the scope of direct transfers of funds.[5]

In addition, transactions involving debt-for-equity swaps and modifications to loan repayment terms (reductions and deferrals of interest payments) are also financial contributions (within the scope of Article 1.1(a)(1)(i)) even though they do not involve any (new) fund transfers, ‘there is no transfer of monetary value’. "Within the meaning of Article 1.1(a)(1)(i), a financial contribution exists if there is a 'direct transfer of funds' and grants, loans and equity transfers are listed as only three possible examples of such transfers. The relevant subparagraphs of Article 1.1(a)(1) therefore define the types of instruments or transactions that can be considered 'financial contributions'. These instruments will only be covered by the SCM Agreement if they are made 'by a government or public entity' and they will only be subsidies covered by the Agreement if they are both beneficial and concrete. The concept of a financial contribution is therefore only one of a set of composite and independent elements, for a subsidy to fall within the scope of the SCM Agreement it must satisfy all three requirements (financial contribution, benefit, concreteness). The waiver and modification of the obligations inherent in such transactions also results in are new rights or obligations, transferred to the old debtor.' A debt-for-equity swap replaces debt with equity, and in such a case, where the debt-for-equity swap is intended to address the deteriorating financial position of the recipient company, the cancellation of the debt represents a direct transfer of funds to the company.[6]

The examples listed in Article 1.1(a)(1)(i) clarify the scope of the term ‘direct transfer of funds’. Most importantly, when considering the ‘medium of exchange’ in the listed examples, it can be seen that all of the examples involve transfers of money (‘funds’), as opposed to in-kind transfers (goods or services, within the meaning of Article 1.1(a)(1)(iii)). The fact that the types of direct transfers listed (grants, loans and equity transfers) are considered as explicit examples only serves to indicate that there may be other types of instruments that would also constitute direct transfers within the meaning of Article 1.1(a)(1)(iii) 1.1(a)(1)(i).

Turning to the specific cases of restructuring transactions as analyzed below, they all have the same nature as the transactions explicitly listed in Article 1.1(a)(1)(i). First, interest rate reductions and deferrals are similar to new loans, as they involve renegotiation/extension of the terms of the original loan. Furthermore, debt/interest forgiveness represents a cash grant, as funds previously provided as loans, subject to interest, are now provided free of charge, as the debt obligation is extinguished. Therefore, all these transactions constitute direct transfers of funds. As for debt-for-equity swaps, it can be seen that equity transfers are explicitly listed as a type of direct transfer of funds in Article 1.1(a)(1)(i). Since debt forgiveness constitutes a direct transfer of funds, the combination of equity injection and debt forgiveness is also covered by that provision. The reason why creditors agree to such transactions is not related to whether the transactions constitute financial contributions but to the issue of benefit (in the sense of whether creditors acting on market principles would enter into such transactions on similar terms). ... ... Equity injection and debt-for-equity swaps have the same effect, in that equity is changed hands (and a subsidy arises if the swap rate is lower than the market). In addition, debt-to-equity swaps include an element of equity injection."

The abandonment or modification of loans (claims), in certain cases, is considered a transfer to new loans, giving rise to new rights and obligations[7]. For example, the modification of an existing loan can be considered a transfer of new rights to the recipient of the modified loan. The borrower's old rights no longer exist, being replaced by new rights. In this sense, the modified loan can be considered a new loan. Thus, the modification of a loan through debt forgiveness involves the transfer of new rights to the borrower, who is now released from the obligation to repay the debt and instead has the right to use the money for free. Similarly, the modification of a loan through an extension of the loan maturity involves the transfer of new rights to the borrower, who is now entitled to borrow money for a longer period. Since the new rights are transferred in transactions such transactions have monetary value and can be accounted for by a person's capital, such transactions may be considered 'direct fund transfers'. It is necessary to look beyond the simple form of a transaction and its effects when determining whether a transaction constitutes a 'direct fund transfer'. The Appellate Body upheld the Panel's conclusion and argued that:

The concept of 'fund transfer' should not be applied too literally and mechanically, otherwise it would fail to capture financial transactions that result in a change in obligations that result in an accumulation of financial resources. Direct fund transfers, as referred to in Article 1.1(a)(1)(i), are not limited to situations where there is an incremental flow of funds to the recipient that increases the recipient's net worth. Therefore, modifications to the terms of pre-existing loans..... are direct fund transfers. The words 'financing, lending and equity injection' follow the word 'example', which indicates that financing, lending and equity injection are cited examples of transactions falling within the scope of Article 1.1(a)(1)(i). This indicates that transactions similar to those explicitly listed are also within the scope of the provision. A debt forgiveness is a form of repayment by a borrower to a lender. Extending the maturity of a loan enables the borrower to enjoy the benefits of the loan over an extended period of time. A reduction in interest reduces the burden of repayment on the borrower. In all these cases, the financial situation of the borrower is improved and therefore there is a direct transfer of funds”[8].

Similarly, the transfer of shares also falls within the scope of “direct transfer of funds”. The transfer of shares is a ‘financial contribution’ because shares in a company are financial rights to a stream of income (in the form of dividends paid from the profits of the company) and are part of the capital of the company on liquidation. Therefore, shares in a company fall within the scope of the term ‘fund’ in Article 1.1(a)(1)(i) and the transfer of shares falls within the scope of the provision ‘direct transfer of funds’.”[9]

In addition, the abandonment (forgiveness) of debt held by a government may also constitute a “direct transfer of funds”: The forgiveness of debt constitutes a financial contribution in the form of a “direct transfer of funds” because government debt is property held by a government that includes certain financial rights (i.e., rights to receive money or its equivalent) that the government has against the debtor. The disposal of government-held debt essentially involves the transfer to the debtor of the government’s financial rights against that debtor, resulting in the cancellation of the debt.[10]

In United States — Large Civil Aircraft (Second Appeal), in a finding that the Appellate Body subsequently declared to be legally invalid, the Panel held that transactions involving the purchase of services are excluded from the scope of Article 1.1(a)(1). The Panel acknowledged that the plain meaning of “transfer of funds” is very broad, but considered that the provisions of Article 1.1(a)(1)(i) should be interpreted in context:

“Article 1.1(a)(1)(i) provides that a financial contribution exists when ‘government action involves a direct transfer of funds (e.g. grants, loans and equity injections)’. If the provisions of Article 1.1(a)(1)(i) are read in isolation, the ordinary meaning of the words ‘government action involves a direct transfer of funds’ would be sufficiently broad to include purchases of services. First, the dictionary definitions of these terms do not suggest that transactions properly described as purchases of services are outside the scope: the definition of the verb ‘transfer’ is ‘a transfer from one person to another’ and the definition of ‘fund’ is ‘a share or sum of money, especially one that is divided for a specific purpose' or 'financing'. Second, there is no restrictive language in the text of this provision. Third, one of the examples of 'direct transfer of funds' referred to in Article 1.1(a)(1)(i) is 'equity injection', which refers to a situation where a government 'buys' something (i.e. shares in a company). Fourth, previous panels and the Appellate Body have not given a restrictive interpretation to these terms. However, the provisions of Article 1.1(a)(1)(i) must be read in their context."

Joint venture arrangements have enough features in common with one of the examples in point (i) (equity injection), and thus fall within the concept of "direct transfer of funds". In the case of an equity injection, the provision of capital by the government to the recipient is made in return for shares. The provider of capital thus makes an investment in the investee enterprise and will receive dividends or any capital gains from that investment. The return on investment will depend on the success of the investee enterprise. At the time the government provides the capital, it does not know how the investee enterprise will perform. The equity investor will benefit from the investment if the enterprise is successful and suffer a loss if the enterprise is not successful. This type of transaction can be replicated through other arrangements, such as by way of a joint venture. [11] In the case of In the United States-Large Civil Aircraft (2nd Complaint), the Appellate Body held that, like equity investors, NASA and USDOD provided funding to Boeing with the expectation of a return (not financial, but in the form of scientific and technical information, discoveries, and data expected to result from the research conducted). Again, like equity investors, NASA and USDOD were uncertain at the time they committed to funding whether the research would be successful. Success would depend on whether any discoveries were made and on the usefulness of the data collected, as well as the scientific and technical information generated. NASA and USDOD’s risk was limited to the amount of their contribution and the opportunity cost of other support they provided to the project, just as an equity investor would be. And like some equity investors, NASA and USDOD contribute to the project by providing access to facilities, equipment, and staff.

3. “For example, financing, lending and equity investments”

The words ‘financing, lending and equity investments’ preceding the abbreviation ‘for example’ indicate that they are cited as examples of direct fund transfer transactions within the scope of Section 1.1(a)(1)(i). These examples, while illustrative, do not limit the conduct covered by subparagraph (i). The inclusion of specific examples will provide guidance on the types of transactions that fall within the scope of ‘direct transfer of funds’”.[12]

- With respect to “grants”, money or items of money’s value are given to a recipient, usually without any obligation or expectation that anything will be provided to the grantor in return. Grants can take many forms. For example, some grants are conditional on the recipient using the money for a specific purpose, and other conditional grants require the recipient to raise a portion of the funds needed for a project.[13]

If the beneficiary company is required to “perform certain obligations” and the “government” is required to reimburse the company for performing certain obligations, it would not be considered a “financial contribution”. The two obligations operate side by side as part of the same transaction even if made at different times. For example, in the US-Wood In the case of softwood sawmills, the company is obliged to undertake silvicultural and forest management activities as a condition of access to timber, and the Government is obliged to reimburse the company for such activities, which is not considered a financial contribution. Although there is a temporal separation between the imposition of silvicultural and forest management obligations and the company’s application and receipt of reimbursement, both are reciprocal in the same transaction. In addition, although the company may be allocated additional timber generated as a result of its silvicultural activities, the additional supply of timber, (even if it is subject to payment of stumpage fees), may be commercially beneficial to the company. Therefore, the company is likely to benefit from the increased productivity resulting from its silvicultural and forest management activities in the form of access to increased timber supplies, and has an incentive to undertake silvicultural activities even in the absence of government reimbursement. However, it is likely that the costs that the company will incur in undertaking forestry and silvicultural activities (without any reimbursement from the government) may exceed the commercial advantage that the company will gain in the form of increased supply (as a result of forestry and silvicultural activities). Therefore, for the company, there may be no commercial benefit in undertaking forestry and silvicultural activities without reimbursement. Therefore, this is not considered a financial contribution.

- "Loans" and "equity injections" are characterized by reciprocity: "With a loan, the lender lends money or the value of money on the basis that the principal will be repaid with interest at an agreed rate (the lender will usually earn a profit on the money borrowed). In the case of an equity injection, the government's provision of capital to the recipient is made in return for the purchase of shares. The provider of capital thus makes an investment in the recipient enterprise and will receive dividends or any capital gains from that investment. The return on the investment will depend on the success of the recipient enterprise. At the time the government provides the capital, it does not know how the recipient enterprise will perform. The equity investor will earn a profit on his capital if the enterprise succeeds and suffer a loss if the enterprise fails."[14]

4. “Potential direct transfers of funds”

A subsidy does not exist when a transfer of funds has actually taken effect[15]: “Under Article 1:1(i) a subsidy exists if the government’s conduct involves a direct transfer of funds or the possibility of a direct transfer of funds and not only if the government actually makes the transfer or the potential transfer of funds (otherwise the text of subparagraph (i) would read: ‘the government directly transfers funds … or engages in potential direct transfers of funds or debts’) … As soon as the government engages in such conduct, a subsidy exists and the question of whether the conduct involves a direct transfer or the possibility of a direct transfer of funds is irrelevant to the existence of the subsidy. If a subsidy is considered to exist only when a direct or potential transfer of funds has actually taken effect, this would render the Agreement completely meaningless and even the usual WTO remedy (i.e. termination of the ". . . will not be able to perform.".

The concept of "direct transferability": "Defining 'loan guarantee' as an example of 'direct transferability or liability' helps us understand the types of measures that may constitute 'direct transferability or liability'. A loan guarantee is a legally binding promise to repay the outstanding balance of a loan when the recipient of the loan defaults. Thus, a promise to repay an outstanding debt in the event of default is a financial contribution (i.e. the ability to transfer funds directly), not an amount that can be transferred in the future in the event of default. ...[16]

The fact that a loan guarantee benefits the recipient when it enables the recipient to obtain the secured loan at a below-market price implies that the benefit of direct transferability arises from the existence of a direct transfer obligation in the event of default. Therefore, when assessing whether a transaction involves a ‘direct transfer of funds’, the focus should be on the existence of a government act that involves an obligation to make a direct transfer of funds that is itself required and likely to confer a benefit to the recipient, separate and distinct from any future transfer of funds. This may be contrasted with a financial contribution in the form of a direct transfer of funds, which would result in a benefit being conferred to the recipient by the government’s act involving a direct transfer of funds.

A commitment to provide funds but not to disburse funds may be a ‘financial contribution’ if it is in the form of a ‘direct transfer of funds’. Just as a disbursement of funds is a ‘direct transfer of funds’, a commitment – ​​or promise – to disburse funds may be considered a ‘potential for direct transfer of funds within the meaning of ‘financial contribution’ in Article 1.1(a)(1)(i).”[17]

A question arises as to whether a ‘potential for direct transfer of funds’ exists only when a direct transfer of funds is required upon the occurrence of some ‘triggering event’ or condition, or whether a potential for direct transfer of funds exists when it is one of a number of possible consequences of a pre-defined condition. The answer is that the mere ‘possibility that the government may transfer funds’ upon the fulfillment of a pre-defined condition is not sufficient to satisfy the definition of a financial contribution. The definition of ‘potential’ is ‘possible as opposed to actual, capable of being or acting; potential’. A loan guarantee is a commitment by the government to assume responsibility for the loan when certain events arise. Thus, the example given in Article 1.1(a)(1)(i) (loan guarantee) suggests that the ability of the government to transfer funds upon the performance of a predetermined condition would not be sufficient to meet the definition of a financial contribution. The ability to transfer funds directly is a ‘possibility’ due to the uncertainty as to whether the triggering event will occur, rather than the uncertainty as to whether funds will be transferred after the predetermined event has occurred.”[18]