The Appellate Body of the World Trade Organisation has rejected an appeal by China against an earlier ruling by a WTO panel against duties imposed on imports of auto parts from US, the European Union and Canada.
WTO's Dispute Settlement Body had, on 18 July, ruled against a Chinese law that required foreign automakers operating there to buy most components from local suppliers or face higher duties.
This is the first time that China lost a case since it joined the Geneva- based world trade body in December 2001.
The case, initially filed in March 2006 by EU and the US, accused China of using a combination of tax incentives, subsidies and currency manipulation to give an unfair advantage to domestic companies.
Canada joined EU and the US in the dispute a year after China began forcing automakers operating on the mainland to use more local components. In April 2005, China began a system of levying tariffs on auto parts based on the number of imports in completed vehicles.
Companies such as Toyota, Ford Motor Co, Volkswagen AG and Renault SA must register with Chinese authorities and provide detailed information on the quantity and value of foreign parts used in their vehicles.
Beijing has a minimum local content requirement of 60 per cent for cars made in China. A vehicle that fails that criterion is considered on par with import of a completely built car and taxed accordingly.
China imposes an import duty of 25 per cent on whole vehicles and only 10 per cent on auto parts.
China says the rules are meant to prevent tax evasion by companies that import whole cars as spare parts to avoid higher tariff rates. But the US argued that the measure puts pressure on foreign auto parts producers to re-locate their manufacturing facilities to China and discourages car makers in China from using foreign auto parts in the assembly of vehicles.
The US, the EU and Canada argued that the difference in duty rates is an unfair discrimination against foreign parts, a violation of international trade rules. WTO judges ruled against China on nearly every point of the case.
China has time to comply with the WTO rules, beyond which it may face retaliatory tariffs on its exports.
''China now has a reasonable period of time to bring its measures into compliance with WTO law,'' the European Commission said in a statement. ''This period of time will be negotiated or determined by arbitration. After which, if China has not remedied the breach of WTO law, the EC may adopt trade sanctions.''
China, last year became the largest source of imports to the US, surpassing Canada, and has run up record trade surpluses with the US over the past six years. The US trade deficit with China reached $195.4 billion in the first nine months of 2008.