I. Procedural Background

1.1. This proceeding has been initiated by two complaining parties, the European Communities and the United States.

1.2. On 2 April 1997, the European Communities requested consultations with Korea under Article XXII:1 of GATT and Article 4 of the Understanding on Rules and Procedures Governing the Settlement of Disputes ("DSU") (WT/DS75/1). The United States (WT/DS 75/2) and Canada 6(WT/DS75/3) requested to be joined in those consultations, pursuant to Article 4.11 of the DSU on 17 and 21 April 1997, respectively. Korea agreed to those requests (WT/DS75/4 and WT/DS75/5). Consultations between the European Communities and Korea were held in Geneva on 29 May 1997, in which the United States and Canada participated.

1.3. On 23 May 1997, the United States requested consultations with Korea under Article XXII:1 of GATT and Article 4 of the DSU with respect to the same matter (WT/DS84/1). Canada (WT/DS84/2) and the European Communities (WT/DS84/3) requested to be joined in those consultations, pursuant to Article 4.11 of the DSU, on 29 May and 5 June 1997, respectively.

1.4. Consultations were held in Geneva on 24 June 1997, between the United States and Korea, and the European Communities and Canada participated as third-parties. Another set of consultations were held on 8 August 1997, to address US requests for further clarifications, but the parties were unable to settle the dispute.

1.5. On 10 September 1997, the European Communities (WT/DS75/6), and the United States (WT/DS84/4), each requested the establishment of a panel pursuant to Article 6.1 of the DSU.

1.6. In its panel request, the European Communities claims that:

1.7. In its panel request the United States claims that:

1.8. The Dispute Settlement Body (DSB) agreed to these two requests for a panel at its meeting of 16 October 1997, establishing a single panel pursuant to Article 9.1 of the DSU with the following standard terms of reference:

1.9. Canada and Mexico reserved their rights to participate in the Panel proceedings as third-parties.

1.10. On 26 November 1997, the United States and the European Communities jointly requested the Director-General to determine the composition of the panel, pursuant to paragraph 7 of Article 8 of the DSU. On 5 December 1997, the Director-General composed the Panel as follows:

1.11. The Panel had substantive meetings with the parties on 5 and 6 March 1998, and on 21 and 22 April 1998.

II. Measures in Issue

1.1. Korea maintains a multi-tiered taxation regime on the sale of alcoholic beverages. Under the Liquor Tax Law of 1949, as amended, Korea creates various categories of distilled spirits, on which it imposes different ad valorem taxes. Under the Education Tax Law of 1982, as amended, Korea assesses a surtax on certain of these sales, determined as a percentage of the established liquor tax.

1.2. Both the liquor tax and the education tax on alcoholic beverages are imposed at the wholesale level. The tax is payable by the manufacturer of the beverages or, in the case of imports, by the importer. Tax liability accrues at the time of shipment from the factory (in the case of alcoholic beverages made in Korea) or of withdrawal from the bonded warehouse (in the case of imported alcoholic beverages).

A. The Liquor Tax Law

1.3. The Liquor Tax Law lays down a system of excise taxes applicable to all alcoholic beverages (whether manufactured in Korea or imported) intended for consumption in Korea. The taxes applied to the categories in dispute are in the form of ad valorem taxes.

1.4. For the purposes of assessing the tax, the value of imported alcoholic beverages includes transport and insurance costs as well as the import duty imposed. In other words, the tax base for imports is the price noted on the import declaration when the goods are withdrawn from the bonded warehouse (i.e., the CIF import value plus duty).¹

1.5. Domestic alcoholic beverages are taxed on the value of production costs, sales costs (including advertising), extraordinary costs, and profits, i.e., the tax base is the price of the goods when they are shipped from the production site.² The categories of distilled spirits established by the Liquor Tax Law, and the applicable tax rates, are described below.

1. Categories

1.6. Liquor Tax Law divides alcoholic beverages into eleven categories, some of which are further divided into sub-categories, and assigns to each of them a different tax rate. These categories include "soju," "whisky," "brandy," "general distilled liquors" (which covers beverages such as vodka, gin, rum and tequila), "liqueurs," and "other liquors" (to the extent that liquors falling within this category may contain distilled spirits or liqueurs falling within any of the preceding categories). Article 3 of the Liquor Tax Law sets forth definitions of these categories.³

(a) Soju

1.7. Article 3.6 has four sub-categories of soju. Sub-categories A and B apparently refer to "distilled soju," while sub-categories C and D apparently refer to "diluted soju."

1.8. Article 3.6.A and 3.6.B states the legal definition of soju as:

1.9. Thus paragraphs (A) and (B) describe two "types" of soju: (i) soju created by fermentation and discontinuous distillation, but without additives; and (ii) soju created by fermentation and discontinuous distillation and containing additives.

1.10. According to Article 3.6.A, distilled soju cannot

1.11. The chapeau of Article 3.6 specifies that soju must have an extract content of 2% or less.

1.12. The legal definition of diluted soju in Article 3.6.C and 3.6.D is as follows soju:

1.13. The definition of diluted soju in 3.6.C and D relies on "neutral spirits," which is defined by Article 3.1 of the Liquor Tax Law as follows:

1.14. Whisky, brandy and "general distilled liquors" are defined in Articles 3.7, 3.8 and 3.9, respectively. The definitions include a 2% extract limitation that distinguishes them from liqueurs. All three include fermentation and distillation as the manufacturing process. However, unlike the definition for soju, they generally specify starch sources.

1.15. Article 3.7 of the Liquor Tax Law, the "whisky" category, includes all types of whisky made totally or partly from sprouted grain and aged in wooden casks, as well as, under certain conditions, admixtures of whisky and other spirits or ingredients.⁴

1.16. Article 3.8, the "brandy" category, includes all liquors distilled from a fermented mash of fruit or fruit wine and aged in wooden casks. Subject to certain conditions, it includes also ad-mixtures of those liquors with other spirits or ingredients.⁵

1.17. The category of "General Distilled Liquors" is a miscellaneous category comprising several kinds of distilled spirits. It consists of six paragraphs.

• Paragraph (A) specifies kaoliang-ju lees as a starch source, and the manufacturing process includes sealing prior to fermenting and distilling; it is designed to address kaoliang-ju, which can be imported from China.
• Paragraph (B) specifies sugar cane, sugar beet, sugar, and/or molasses as a starch source; it addresses rum.
• Paragraph (C) specifies "fruits of juniper tree" as an ingredient; it addresses gin.
• Paragraph (D) specifies filtering of the alcohol; it addresses vodka.
• Paragraph (E) merely concerns "materials mainly containing starch or sugar produced by fermentation and distillation." It covers tequila and any distilled spirit. Its wording is the same as that used in the first part of the definition of "neutral spirits".⁶
• Paragraph (F) addresses mixed distilled drinks (e.g., gin and rum mixed drinks).

(c) Liqueurs

1.18. Article 3.10, the "liqueurs" category, covers liquors with more than 2% extract content produced by distillation of a starch or sugar source to which ginseng juice, fruits or fruits extracts are added.⁷

1.19. Article 3.11 sets forth the category of "other liquors," a residual category including all liquors (whether fermented or distilled) not falling within any of the other categories defined by the Liquor Tax Law.⁸ It includes inter alia admixtures of whisky and brandy.

2. Tax Rates

1.20. The Korean law imposes different ad valorem tax rates on the various categories and sub-categories of distilled spirits. Pursuant to the definitions, soju is given a tax rate of 35 to 50 percent, while other distilled alcoholic beverages are taxed at 80 to 100 percent. The applicable liquor tax rates are:⁹

B. The Education Tax Law

1.21. The Education Tax Law of 1990 is assessed as a surtax on the sale of a variety of items, including most alcoholic beverages. For alcoholic beverages, the applicable rate is determined by reference to another tax -- the applied liquor tax rate.¹⁰ For those assessed a liquor tax rate of 80% or greater, the law imposes an education surtax calculated as 30% of the liquor tax imposed.¹¹ For alcoholic beverages assessed a liquor tax rate of less than 80%, the law imposes an education surtax calculated as 10% of the liquor tax imposed.

1.22. This tax structure results in a 30% surtax for imported distilled alcoholic beverages, including whisky, brandy and general distilled liquors (vodka, rum, gin, tequila, shochu, etc.) except for imports of Japanese shochu, which are classified for tax purposes and taxed at 10%. Of all distilled alcoholic beverages, only soju and liqueurs are subject to the lesser 10% surtax. Prior to 1995, soju was exempted from the Education Tax. However, after negotiations between Korea and the European Communities that Korea agreed to subject soju to the Education Tax at a rate of 10%.

1.23. The applicable rates on the categories concerned by this dispute, expressed as a percentage of the amount payable pursuant to the Liquor Tax, is as follows:

To continue with Factual Arguments

¹ Article 19.2 of the Liquor Tax Law.

² Presidential Decree, Article 26.

³ A translation of the relevant provisions of Article 3 is provided as US Exhibit A.

⁴ See Article 3.7 of the Liquor Tax Law. The whisky definition includes three subparagraphs. Paragraph (A) specifies only sprouted grains and thus addresses malt whisky. Paragraph (B) appears to broaden the starch source to normal grain as well as sprouted and thus addresses ordinary grain whisky. Both (A) and (B) provide for aging in wooden barrels and thus address premium brands of whisky. Paragraph (C) addresses premium blended whisky and/or whisky with sugars, acids, seasonings, fragrances, colouring, or carbon dioxide added.

⁵ See Article 3.8 of the Liquor Tax Law.

⁶ See Article 3.1 of the Liquor Tax Law.

⁷ See Article 3.10 of the Liquor Tax Law.

⁸ See Article 3.11 of the Liquor Tax Law.

⁹ The applicable tax rates are set forth in Article 19.2, and Korean Taxation: 1997, � 3(b) p. 188 (Korean Ministry of Finance and Economy).

¹⁰ In addition to the liquor tax, other taxes upon which the Education Tax is levied include the Special Excise Tax, the Per Capita Inhabitant Tax, the Registration Tax, the Horse Race Tax, the Property Tax, the Aggregate Land Tax, the Tobacco Consumption Tax, the Automobile Tax and the Transportation Tax.

¹¹ Education Tax Law, Art. 5.