ABSENCE OF SUBSIDIES CAUSING INJURY AND ADVERSE TRADE EFFECTS

4 April 2001

Prepared by:

THE KOREA SHIPBUILDERS' ASSOCIATION

3^rd Floor Officetel World 65-1 Unni-dong Chongro-ku Seoul, Korea

Tel: 00 82 2 766 4631

Fax: 00 82 2 766 4307

Website: www.koshipa.or.kr

　

Pursuant to Council Regulation (EC) No 3286/94 of 22 December 1994 laying down Community procedures in the field of the common commercial policy in order to ensure the exercise of the Community's rights under international trade rules, in particular those established under the auspices of the World Trade Organization¹ (the "TBR Regulation"), no commercial policy measures can be adopted as regards obstacles of trade unless injury or adverse trade effects are shown to have been caused by the obstacle to trade.

　

The KSA and its members submit that

　

　

The KSA submits the present paper in support of the above conclusion and in line with the arguments developed at the time of the hearing held on 29 March 2001. Also, KSA submits herewith the economic analysis prepared by the shipbuilding specialists, Drewry Shipping Consultants Ltd. and by Professor Aubrey Silberston of London Economics which is the basis for the conclusions drawn by KSA that no injury or adverse trade effects were caused by the alleged subsidies.

　

The Complaint alleges that:

　

　

All of these allegations are strongly denied. European yards surrendered their dominant position in the shipbuilding market to Japan in the 1960s and 1970s before Korea built up any significant market share.

　

European yards had lost the ability to compete with either Korea or Japan for larger series built vessels such as tankers, bulk carriers and large container vessels well before 1997.

Lower labour costs, much higher productivity and lower materials costs give Korean yards a Decisive, and completely legitimate, competitive advantage in building these types of vessel.

　

The depreciation of the Korean Won from around 800 Won to the US Dollar to a low of 1,750 Won to the Dollar in 1997, gave Korean yards a very substantial further competitive advantage over European yards since shipbuilding contracts are priced in US dollars.

　

In addition, the cost of materials has fallen and Korean yards have made further productivity gains since 1997. As a result Korean yards have been able to further improve their ability to quote competitive prices.

　

Korean yards do not enjoy subsidies from the Korean Government, unlike European yards who have enjoyed a range of both open and hidden subsidies over many years. European yards are unable to compete because of high labour costs, lack of investment, high material costs and failure to achieve productivity levels matching the best Korean and Japanese shipyards. Korean shipyards are not to blame for any of these factors.

The KSA and its members submit that neither the Korean Government nor any other public body has bestowed on the Korean shipbuilders any subsidy that is prohibited or actionable under Articles 3 and 5 of the ASCM. They reject the allegations made in the CESA Complaint and submit that this Complaint contains no evidence of the existence of such subsidies. In addition, as the European Commission officials were able to verify during the on-site verifications from 5 March through 20 March, the export credit facilities, the workout/corporate reorganisation programs and the tax deferrals did not entail any subsidies in violation of the provisions of the ASCM.

　

The KSA and its members provided extensive co-operation in this investigation under the Trade Barrier Regulation by responding to the Commission's Questionnaire and agreeing to the on-site verifications in Korea. During the on-site verifications, KSA's members responded to the best of their ability to the questions raised by the Commission officials.

　

In summary:

　

　

Hence, the examination procedure currently on-going under the EU's Trade Barrier Regulation should be terminated forthwith.

　

In support of their position, the KSA and its members submit the following arguments. These reflect the position of the KSA and its members and should not be assimilated to a position expressed by the Korean Government.

　

　

　

Korean exporters who export or produce designated capital goods are eligible for Export Loans. Since KEXIM's export loans meet all OECD Guidelines, including minimum interest rate of 8% and maximum repayment period, they are compatible with the OECD Guidelines and, hence the 2nd paragraph of Item (k) to Annex I of the Illustrative list of the ASCM. Therefore, they are not prohibited export subsidies.

　

　

KSA submits that the Pre-Shipment Export Credits are covered by the safe harbour provision of the 1^st paragraph of Item (k) to Annex I of the ASCM. In particular, KSA notes that:

　

　

In general, in Korea, as elsewhere in the world, "corporate restructuring" generally refers to programs implemented by creditor banks and financial institutions, on the one hand, and debtor companies on the other. The goal of the creditors is to improve the capital structure of those debtor companies considered viable, thereby enhancing the value of the credits extended by the financial institutions. Thus, corporate restructuring in Korea has been led by the creditor banks and financial institutions based on purely commercial considerations with a view to minimising their potential losses that may arise due to the financial conditions of the distressed companies.

　

Specifically, the corporate restructuring of Halla Engineering and Heavy Industry (Halla) and Daedong Heavy Industries (Daedong) and the corporate workout of Daewoo Heavy Industries (Daewoo) are not actionable subsidies in that:

　

　

　

　

　

All companies meeting objective criteria are eligible for corporate workout and, thus, the Korean corporate workout program is de jure non-specific.

　

　

The goal of the workout programs was to achieve debt restructuring and reorganisation for the companies before their credit problems forced them into corporate reorganisation and the jurisdiction of bankruptcy courts. According to the Operational Guidelines for Workout Agreement, if a company filed an application for a workout program, the creditor banks review the applicant's financial and management status to assess the viability of that company. For financially distressed companies to be eligible for the workout program, the creditor banks must consider them to be viable in the long run. In addition, applicants would be automatically disqualified for the program if they fell into any of the following categories:

　

　

　

For these reasons, both the corporate reorganisation and workout programs are de jure and de facto non-specific. All companies meeting objective criteria were eligible for the corporate reorganisation and workout programs.

　

　

The corporate reorganisation and workout programs conferred no actionable benefits on shipbuilders. All creditors, whether government-held or not, participate on an equal footing in the creditor committees to determine the conditions under which the company concerned can be returned to profitability to the benefit of all creditors.

　

In both the corporate workout and corporate reorganisation programs, creditors analyse the long-term viability of the company and assess whether the viability of the company as a going concern is greater than the liquidation value.

　

Based on valuation reports, the creditors agreed to restructurings that allowed them to obtain equity for consideration for debt restructuring. Therefore, the creditors purchased equity in the shipbuilding companies in arm's-length market transactions.

　

　

The Korean creditor banks operating under Korean bankruptcy laws (in this case Corporate Reorganisation Laws) do not meet the criteria for providing a financial contribution contained in Article 1.1(a)(1)(iv) of the ASCM. The corporate reorganisation procedure is carried out exclusively by the courts strictly in accordance with the Corporate Reorganisation Law. The Korean Government does not exercise control or supervision over the decisions of the creditors in the Corporate Reorganisation Proceeding.

　

The corporate workout program is carried out pursuant to the Corporate Restructuring Agreement (signed by 210 financial institutions in 1998). This Corporate Restructuring Agreement established the principles of the corporate workout program. Moreover, the Operational Guidelines adopted by the creditor financial institutions under the Workout Agreement established the guidelines for those creditors to follow in evaluating applicants. The Korean Government did not maintain control or supervision over the decisions of the creditors in the Corporate Workout Procedure, and thereby attempt to regulate through them. Thus, in the workout program, as in the Corporate Reorganisation program, the Korean Government did not "direct" or "entrust" the functions of corporate reorganisation to the financial institutions as required by the first criterion of Article 1.1(a)(1)(iv).

　

In addition, in both the Corporate Reorganisation and Workout Programs, the banks are operating in a traditional banking capacity, performing functions normally performed by banks - not by governments. Thus, even assuming that certain functions have been entrusted to the banks through the bankruptcy/Corporate Reorganisation Laws, or through the Corporate Workout Agreement, such functions - those of issuing loans, forgiving indebtedness, and accepting equity in exchange for debt - are not those normally followed by governments but indeed precisely the functions carried out by private banks around the world who are faced with corporate reorganisation proceedings. Thus, the third criterion found in Article 1.1(a)(1)(iv) - that the function entrusted to the private body must be one that is normally carried out by the government and "in no real sense differs from practices normally followed by governments" -- is not met.

　

Under the Korean Corporate Reorganisation Law and the Workout Agreement, Korean banks operate within a framework set by the law and by their self-regulating implementation agreement. The creditor banks negotiate with one another and adopt autonomous resolutions on whether and how to restructure the debts which they hold in the debtor companies concerned. As such, they lack that key governmental function - the power to "regulate" as opposed to simply operate pursuant to a legal framework.

　

The same applies to government-owned and controlled banks. The mere presence of government ownership or control of a commercial institution, without more, cannot transform that commercial institution into a "government" or "public body." A financial contribution is provided only when all three criteria of Article 1.1(a)(1)(iv) are met. For the reasons set forth above, no "financial contribution" exists within the meaning of the ASCM.

　

　

KAMCO purchases Non-Performing Loans ("NPLs". hereinafter) from financial institutions at market value - which is a fraction of book value -- and sells the acquired NPLs in a bundle. KAMCO typically pays for the purchase in kind with its own issuance of bonds.

　

As can be seen from a careful review of these practices, KAMCO is not providing any benefit to the shipbuilding industry. To the extent that any benefit is provided, it is to the creditors of the shipbuilding industry. The financial institutions come to KAMCO and request it to purchase their NPLs. Then, both parties negotiate on the market price. In purchasing NPLs, KAMCO does not consider the industry in which the debtor company is as a factor affecting its decision. Moreover, because KAMCO is purchasing the loans at market prices, no benefit should be conferred to those creditors. In addition, as discussed during the on-site verification, in all if not most instances, KAMCO has the benefit of a put option pursuant to which the creditors must re-purchase the NPLs at original sales price plus interest or have the benefit of an adjustment to be settled by the creditors if the NPLs are sold below KAMCO's purchase value.

　

KAMCO has purchased the NPLs owned only by the financial institutions. As the European Commission acknowledged in recital (206) of the Commission Regulation (EC) No. 618/1999 of March 23,1999,the main purpose of KAMCO is to liquidate the NPLs held by financial institutions. The Commission Regulation also clearly states that the services are only available to financial institutions.

　

By contrast to those creditor financial institutions, the shipbuilding industry still has to repay to KAMCO or the entity ultimately purchasing the NPLs from KAMCO the full amount of the loan. In essence, at the time that KAMCO purchases the NPLs, the shipbuilder is not "off the hook" on the original loan. Accordingly, to the extent that any benefit is conferred, it is to the creditors, not the shipbuilders, who are still responsible for repaying the original loan.

　

The tax exemptions provided for in the Special Tax Treatment Control Law ("STTCL") are provided to industries across a wide spectrum of the Korean economy and are not specific.

　

As regards the two tax deferrals noted during the on-site verification, i.e., the taxation on in-kind contribution and the taxation on spin off under a workout plan, the following is noted:

　

　

Article 38 of the STTCL provides tax deferral to companies that make in-kind contributions of certain assets to a newly established company, and also provides certain tax incentives for the new companies that acquire such assets through in-kind contribution. According to Article 38 of STTCL, a company shareholder can defer payment of corporate income taxes on any capital gains arising from the in-kind contribution until the company sells the acquired assets.

　

Article 38 of STTCL was introduced in December 1997,and the incentives under this provision are not specific to any particular companies, industries or regions and are available for all industries.

　

Article 46 of the Corporate Tax Act was also introduced as early as December 1997 before introduction of the Corporate Workout Program in June 1998. Under this provision, the gain on the transfer of lands, buildings and structures due to the spin-off is not included in calculating the taxable income for corporate income tax, if the spin off meets the following criteria.

　

　

The rationale of this provision is that the spin-off, which is carried out by issuance of new company's stock to the existing shareholders of the old company, does not involve any actual transfer of assets and, thus, Article 46 only confirms that the spin-off does not constitute any taxable event.

　

Article 45-2 of the STTCL was introduced only to complement Article 46 on October 21, 2000.In connection with spin-offs carried out in the framework of workout procedures, the minority shareholders of the old company typically requested that they be attributed more shares in the new company(ies)than their shareholding ratio in the old company. In order for the companies under the workout to accommodate this requirement, while entertaining the tax treatment under the existing Article 46 of the Corporate Tax Act, they had to go through rather complicated procedures, such as a proportionate issuance of shares and the subsequent disproportionate capital reduction or adjustment. In this situation, Article 45-2 was introduced in order to allow spin-offs to take place in a simplified procedure without a proportionate allocation of shares.

　

As shown above, Article 45-2 of STTCL does not provide any new tax incentives but merely a simplified procedure for the companies under the workout in relation to the tax incentives already available under Article 46 of the Corporate Tax Act.