III. Factual Arguments

A. European Communities

1.1. The European Communities proceeds from the premise that in response to its reiterated requests, Korea has reluctantly acceded to make a number of changes to its liquor tax system which have reduced (but by no means eliminated) the difference between the internal taxes applied to soju and those applied to other categories of distilled liquors.

1.2. The European Communities states that as of 1 January 1991, Korea abolished the Customs Defence Tax, which until then had been applied only to imported liquors. It further states that on the same date, Korea also abolished the Liquor Defence Tax, which had been levied at a lower rate on soju than on other distilled spirits and liqueurs. Further, the European Communities states that Korea eliminated an uplift ratio of 1.0:1.1 (the so-called "times 1.1 multiplier") which had been applied in order to inflate artificially the import duty paid value on which the Liquor Tax is assessed in the case of imported beverages.

1.3. The European Communities adds that these amendments were followed by a reduction of the Liquor Tax rates on the category of "whisky" from 200% to 150%, and on the category of "general distilled liquors" from 100% to 80%, both effective from 1 July 1991. According to the European Communities, this decrease, however, was partially nullified by a simultaneous increase in the Education Tax rates, which were raised to 30% for most distilled liquors other than "soju". At the same time, the category of "soju" was divided into the sub-categories of "distilled soju" and "diluted soju" and the rate on "distilled soju" raised from 35% to 50%.

1.4. According to the European Communities, in June 1993, it reached an agreement with Korea (the "1993 Agreement") whereby Korea undertook to reduce progressively over a period of two years the liquor tax rate applicable to the "whisky" and "brandy" categories from 150% to 100%. The European Communities asserts that Korea further agreed to levy the Education Tax on both sub-categories of soju (which had until then been exempt from such tax) at a rate of 10% as from 1 January 1994¹² and to increase the tax on admixtures containing whisky or brandy (which are mainly bottled in Korea) from 80% to 100%.

1.5. The European Communities further asserts that the 1993 Agreement envisaged that a new round of consultations would take place in 1996 in order to discuss further reductions of the remaining tax differences. According to the European Communities, as compensation for the continued application in the meantime of much lower taxes to soju, Korea agreed to further reduce the effectively applied import duties on whisky, brandy other than wine brandy (which already benefited from a 15% applied rate), rum, gin, vodka and liqueurs (but not on soju) from 30% to 20%.

1.6. The European Communities allege that the consultations provided for by the 1993 Agreement eventually took place in January 1997. Nevertheless, according to the European Communities, Korea did not meet the EC's request to eliminate the remaining tax differentials so as to bring its liquor tax system in conformity with the GATT.

The Korean Market for Distilled Liquors

1.7. The European Communities states that the Korean market for distilled spirits and liqueurs was virtually closed to imports until the late eighties. According to the EC's argument, until 1 January 1989, imports of distilled spirits in bulk were subject to quotas, whereas imports of distilled spirits in bottles were prohibited until 1 July 1989, and thereafter subject to quantitative restrictions until 1 January 1990.

1.8. The European Communities further argues that, Korea applied prohibitively high import duties: 150% until 1984; 100% until 1988; and 50 % until 1991. According to the European Communities, until March 1990 Korea applied an import deposit requirement. The EC's position is that, currently the applied import duty rate is 20% for all distilled spirits and liqueurs, except brandy (which is subject to a 15% import duty) and soju (which is subject to a 30% import duty).¹³

1.9. The European Communities further argues that, following the elimination of the import quotas and a substantial reduction of import duties and internal taxes, imports of distilled spirits and liqueurs have grown steadily but still represent only around 3.5% of the market. According to the European Communities, this share is unusually low. The European Communities is of the view that in most other OECD countries the share of imported sprits is between 30% and 40% of the market for distilled liquor. By comparison, the European Communities states that in Japan the share of imported spirits was 8% in 1995, despite the fact that at that time Japan applied a system of discriminatory internal taxes similar to the one in dispute.

1.10. According to the European Communities, the Korean spirits market is overwhelmingly dominated by soju. In 1996 sales of soju amounted to 90 million 9L cases (810 million litres), which represents as much as 94% of the distilled spirits market.¹⁴ Soju's position, however, is allegedly being eroded by growing sales of imported spirits and liqueurs, and in particular of whisky. Over the past few years, sales of soju have allegedly increased at a lower pace than the total spirits market (between 1993 and 1994 sales of soju even decreased in absolute terms). As a result, the market share of soju fell from 96.37 % in 1992 to 94.39 % in 1996.¹⁵

1.11. The European Communities states that imports of soju are insignificant. In 1997, Korea allegedly imported just 1,625 litres.¹⁶ In contrast, argues the European Communities, Korea exports large quantities of soju. The European Communities further asserts that during the first eleven months of 1996, exports of soju totalled 43 million litres of soju, which represents about 5% of the Korean soju production. According to the European Communities, the main export market is Japan, where soju is considered for customs and tax purposes as being the same product as local "shochu".

1.12. The European Communities further asserts that almost all soju sold in Korea is diluted soju. Distilled soju is estimated to account for just over 1% of the total sales of soju. While diluted soju is generally an inexpensive liquor, distilled soju may fetch very high prices, similar to those paid for imported premium brands of whisky.

1.13. The European Communities argues that, confronted with growing sales of western-style liquors, the manufacturers of diluted soju have been forced to address what are generally perceived by Korean consumers as negative attributes of that liquor as compared with the "western style" distilled liquors: inferior quality, harsh taste, hangover effects.

1.14. According to the European Communities, this has led to the emergence of new so-called "premium soju" brands, whose distinctive characteristics are a milder taste, the use of flavouring (e.g. with honey) and/or ageing processes, and more sophisticated packaging. The European Communities asserts that the prices for premium soju brands are between two and three times higher than those for standard diluted soju. According to the European Communities, in spite of that, sales of premium soju are growing very rapidly. By EC estimates, in 1996 they represented 6% of soju sales and reached 10% in 1997.

1.15. The European Communities points out that whisky is the largest category of distilled spirits after soju. Sales of whisky allegedly increased from 11 million litres in 1992 to 27 millions in 1996, i.e. by almost 140%. As a result, the European Communities argues that the share of whisky rose from 1.53% in 1992 to 3.14% in 1996. According to the European Communities, one of the main reasons for this increase is the progressive reduction in the applicable liquor tax rate from 200% in 1990 to 100% in 1996. The European Communities further argues that Scotch whisky imported from the European Communities, whether in bottles or in bulk, accounts for virtually all of the sales within this tax category.

1.16. The European Communities further argues that the category of brandy is still very small but growing rapidly. The increase has allegedly been particularly remarkable in the case of cognac, which went up from just 13,000 litres in 1992 to 193,000 litres in 1996. As in the case of whisky, the argument goes, this increase is in part due to the progressive reduction of the Liquor Tax rate from 150% in 1990 to 100% in 1996. Almost all brandy sold in Korea is imported, whether in bottles or in bulk.

1.17. According to the European Communities, the category of "General Distilled Liquors" is also very small. In the EC view, unlike sales of whisky and brandy, sales of liquors falling within this category have stagnated and in some cases even declined. One of the reasons for this, according to the European Communities is that, unlike whisky and brandy, this category has benefited only from a marginal reduction of taxes. The European Communities alleges that. Although the liquor tax rate on this category was lowered from 100% to 80% as from 1 July 1991, this reduction was almost totally offset by a simultaneous increase of the applicable Education tax rate from 10% to 30%.¹⁷ A significant proportion of sales within this category is imported. According to estimates of the EC industry, imports would represent approximately 20% of the sales of gin, 50% of the sales of rum and 70% of the sales of vodka.

1.18. The European Communities further alleges that pre-mixes of distilled liquors and non-alcoholic beverages account for a major portion of sales (95% according to the estimates of the EC industry) within the category of "liqueurs". According to this argument, soju-based cocktails (e.g. lemon flavoured soju, cherry flavoured soju) account for the vast majority of the sales of pre-mixes. The EC view is that soju cocktails are a relatively new product targeted at the young generation and enjoy considerable success. According to the European Communities, during 1995 alone, sales of soju cocktails increased by 1250%. There are no imports of soju cocktails.

1.19. In contrast, the European Communities argues that it may be estimated that as much as 90% of the sales of "authentic" or "single item" liqueurs are imported. Sales of this type of "liqueurs" have been growing off a small base at 15-20% every year and are currently estimated to represent 300,000 litres out of total market for liqueurs of 13.5 million litres.

1.20. The European Communities further argues that although no official sales figures have been made available by the Korean Government, the EC industry estimates that while sales of whisky and other imported liquors declined during 1997, sales of soju would have increased. As a result, the European Communities argues, soju may have regained its lost share of the market. This new development is the result of extraordinary circumstances.

1.21. According to the European Communities, in the first place, the depreciation of the Korean won, which has made imported liquors more expensive¹⁸. To this, states the European Communities, it must be added the effects of the boycotts against imported products orchestrated by civic groups and by business associations such as the Central Council of Korean Night-spots' Operators during the first months of 1997. Finally, according to the European Communities, the financial crisis which broke in October of last year, and the ensuing slow down in the Korean economy has made consumers much more price conscious and further depressed the sales of imported liquors to the benefit of the less taxed and less expensive soju.

1.22. The European Communities argues that western-style liquors used to be perceived by Korean consumers as "luxury" items. According to the European Communities, at present the prices for western-style liquors remain much higher than the prices for diluted soju. Nevertheless, according to the European Communities, following the lifting of the import quotas and the lowering of import duties and liquor taxes, there has been a clear trend towards lower consumer prices, broader availability in all sales channels and consumption patterns which are more similar to those of soju.

1.23. The European Communities concludes that the remaining tax differentials stand as an obstacle to that trend and hinder further competition between soju and imported western-style distilled spirits and liqueurs.

B. United States

1.24. From the US perspective, the products concerned by this dispute are soju, a locally produced distilled liquor, on the one hand, and imported distilled spirits classified under the Harmonized System (HS) heading 2208, on the other hand,¹⁹ including spirits such as vodka, whisky, gin, rum, brandy and liqueurs. Exports in 1996 of U.S. distilled spirits to Korea were allegedly only $1.8 million compared to an average export level in recent years of $90 million to Japan.

1.25. The United States alleges that the current tax system and the state of the Korean market grows out of many years of protecting soju. It claims that although Korea has dismantled some of its trade barriers to imports over the last ten years (an effort that has produced inroads for imported spirits in the Korean market), Korea retains two tax laws that categorises liquor products arbitrarily, and imposes corresponding discriminatory tax rates.

1.26. The United States further alleges that Korea's current tariff and tax regime governing the sale of alcoholic beverages has grown out of a historically restrictive market for alcoholic beverages that has shaped the Korean market as it stands today.

1.27. The United States asserts that after 1949, high tariffs, quotas and other measures were used by the Korean government to discourage the importation of distilled alcoholic beverages and conserve the country's foreign exchange reserves. It cites, for example, that in the 1970's Korea assessed a duty of 150% C.I.F. on whisky imports. Until January 1989, Korea maintained quota restrictions on bulk imports of whisky, and it prohibited the importation of bottled whisky until July 1989. Importers were required to pay a deposit on the value of their imports, and the government permitted only twelve licensed importers until 1989.

1.28. The United States further alleges that in the 1980's, Korea began to liberalize these barriers to distilled spirits imports by reducing applied rates on whisky. In 1982, the government reduced the rate of duty imposed on whisky from 150% to 100% for products certified for use in tourist hotels. In 1984, the government extended this rate reduction to all whisky imports regardless of destination. In 1988 the customs duty was further cut to 50%, where it remained until a reduction to 40% in 1991, followed by 30% in 1993. In 1996, Korea applied a tariff rate of 20% on whisky. Korea's WTO bound rate, as a result of negotiations during the Uruguay Round, descends from a base of 100% in 1995 to a final rate of 30% in 2004 in equal annual instalments.

1.29. The United States also alleges that, following pressure from the European Communities, Korea has also recently dismantled a number of its non-tariff barriers against distilled alcoholic beverages. In 1988, Korea eliminated the import deposit requirements for small and medium sized importers. In 1989, it reduced this deposit for large importers from 10% to 5%; increased the number of licensed importers from 12 to 25; lifted quota restrictions on the import of bulk whisky; and permitted the import of whisky bottled abroad for the first time, albeit subject to a quota. In 1990, the government removed this quota, abolished the import deposit requirement for large importers, and removed government limitations on the number of licensed importers. In 1991, Korea allowed foreign investment in the importation and distribution of spirits.

1.30. The thrust of the US case is that concurrent with these tariff and non-tariff measures, Korea maintained a discriminatory system of internal taxes weighted against imported alcoholic beverages. According to the United States, after World War II, taxes on whisky and beer provided the government with a steady and easily collected form of revenue. However, in the face of increasing pressure, especially from the EC, Korea enacted a series of tax reductions on some imported distilled alcoholic beverages. Korea allegedly decreased the liquor tax rate on whisky and brandy from 200% to 150% in July 1991, 120% in January 1994, and 100% in January 1996.

To continue with The Current Korean Market for Distilled Liquors

¹² The EC claims that Korea did not implement this commitment until 1 January 1995.

¹³ A table summarising the recent evolution of the tariff treatment of the products concerned by this dispute is included in EC Annex 4.

¹⁴ EC Annex 5.

¹⁵ EC Annex 6.

¹⁶ EC Annex 7.

¹⁷ EC Annex 2.

¹⁸ The average monthly exchange rate between the Korean Won and the ECU fell from 1028.35 Wons to an ECU in January 1997 to 1616.28 wons in December 1997, i.e. by almost 60 %.

¹⁹ Undenatured ethyl alcohol of an alcoholic strength by volume of less than 80 percent vol.; spirits, liqueurs and other spirituous beverages; compound alcoholic preparations of a kind used for the manufacture of beverages.