(a) Soju and all other Distilled Spirits and Liqueurs Have the Same Basic Physical Characteristics and are Apt for the Same end Uses

1.124. The complainants argue that the notion of "directly competitive and substitutable" products is broader in scope than that of "like" products. According to the complainants, two products which are too "different" in terms of physical properties or of end uses to qualify as "like" for the purposes of Article III:2, first sentence, may still be "competitive or substitutable" in the sense of Article III:2, second sentence. The complainants note that as recently recalled by the Appellate Body in Canada - Certain Measures Concerning Periodicals⁸⁷, a case of "perfect substitutability" would no longer fall within the second sentence of Article III:2, but within the first sentence.

1.125. The complainants further note that the Panel Report on Japan - Taxes on Alcoholic Beverages I indicated that:

1.126. According to the complainants, the basic physical properties of soju and the other categories of liquors concerned in this dispute are essentially the same. All distilled spirits are concentrated forms of alcohol produced by the process of distillation. In the complainants' view, at the point of distillation, all spirits are nearly identical, which means that raw materials and method of distillation have almost no impact on the final product. Post-distillation processes such as ageing, dilution with water or addition of flavourings, do not change the basic fact that the product sold is still a concentrated form of alcohol.

1.127. The complainants present a table below which compares the key characteristics of soju and the main types of distilled sprits at issue in this dispute. This table purports to show that all of them have essentially the same physical characteristics. For instance, according to the complainants, the main differences between soju and whisky, the largest category after soju, are limited to the following:

1.128. The complainants argue that in practice, the above differences are even less important than they might appear at first sight:

1.129. The complainants argue that the above differences are clearly not sufficient to prevent soju and whisky from being directly "substitutable" or "competitive" products in the sense of Article III:2, second sentence. According to the complainants, the existence of similar differences between whisky and Japanese shochu did not preclude the 1987 and 1996 Panels on Japan - Taxes on Alcoholic Beverages from finding that those liquors were in competition on the Japanese market.⁸⁹

1.130. The complainants further argue that having essentially the same basic physical properties, soju and all the other distilled spirits and liqueurs are objectively apt to serve the same end-uses:

1.131. In the complainants' view, the above reasons alone are more than sufficient to conclude that soju and all other distilled spirits and liqueurs are objectively "substitutable" and potentially "competitive" in the Korean market. In addition, the complainants argue that there is conclusive evidence that, despite the distortions introduced by the Korean liquor tax system, competition between soju and other distilled liquors on the Korean market is not just potential but, to a significant degree, also actual.

(b) Soju and the other Distilled Spirits and Liqueurs are Sold in the Same Sales Channels and are Promoted and Advertised in a Similar Way

1.132. The complainants assert that the consumption of western-style liquors used to be confined to upmarket restaurants and entertainment establishments. However, the argument goes, over the past few years western-style liquors have gained considerable distribution penetration. According to the complainants, with the main exception of traditional Korean-style restaurants, where soju and other traditional local liquors continue to predominate, western-style liquors are now widely available alongside soju in most sales channels, both for on-premise and off-premise consumption.

1.133. As evidence of the increasing availability of western-style liquors, the complainants point to a recent survey completed by Hankook Research in May 1997 and covering more than 700 sales outlets, which allegedly found that the leading brands of whisky were sold in a majority of outlets within each relevant category. More specifically, the survey established that 'Imperial', 'Passport' and 'Dimple', the "three big" brands of whisky, were sold in 76%, 81% and 61%, respectively, of the surveyed on-premise outlets and in 64%, 98 % and 85%, respectively, of the surveyed off-premise outlets.⁹⁰

1.134. The complainants further purport to show by the photographs included in their exhibits⁹¹ that off-premise outlets often display soju and other distilled sprits and liqueurs side-by-side on the same shelves, thus providing evidence in their view, that both the retailers and the public regard them as being in competition.

1.135. According to the complainants, the advertising of soju, and especially of premium soju, is very similar to the advertising of western-style liquors and tends to emphasise precisely those characteristics which are generally attributed by Korean consumers to western-style liquors, such as pureness, mild taste, maturity, no-hangover effects, etc.⁹²

1.136. The complainants assert that likewise, the packaging of soju, and in particular of premium soju, is similar to the packaging of western-style spirits and liqueurs.

1.137. The complainants state that, like their Japanese neighbours, Korean consumers at first perceived Western-style liquors as "luxury" items to be offered as gifts or to be consumed only on special occasions and at special places. Over time, however, there has been, both in Japan and in Korea, a clear trend towards consumption of all types of distilled spirits on more and varied occasions, and in different methods of consumption, i.e. in mixed drinks, warm, cold, etc. According to the United States, the expanding methods and venues of consumption have also been aided by greater availability of all types of spirits in all sales channels.

1.138. The complainants further state that, to capitalize on Korean consumer's expanded awareness, the soju market has been creating new categories and brands of soju at a fast pace. Most of the activity has been in the recently established premium soju segment. For example, in Korea, Bohae Brewery first successfully used the strategy of incorporating flavoured additives such as honey to soju in its Kim Sat Gat brand soju. Kim Sat Gat was quickly followed by other premium sojus that also contained honey, or were flavoured by aging in wood.

(c) Consumers' Demand for Soju Has Been Responsive to the Changes in the Price of Whisky

1.139. The complainants argue that there is statistical evidence indicating that, despite the competitive distortions created by Korea's liquor tax system, demand for soju has been responsive in the past to changes in the prices of the other categories of distilled liquors, and in particular to changes in the price of whisky.

1.140. The complainants further argue that the applicable liquor tax rate on whisky has been progressively lowered from 200% in 1990 to 100% in 1996. According to the complainants, during the same period, the applicable import customs duties were lowered from 70% to 20%. These tax and tariff changes were followed by a reduction of the prices for whisky and a spectacular increase in sales from 11 million litres in 1992 to 27 million litres in 1996.

1.141. The complainants argue that, the increase in sales of whisky took place, to a significant extent, at the expense of soju. According to the complainants, until last year sales of soju have grown at a lower pace than overall demand for distilled spirits and liqueurs. As a result, the complainants argue, soju lost market share, mainly to the benefit of whisky. Thus, the argument goes, whereas the market share of soju fell from 96.37% in 1992 to 94.39% in 1996, during the same period the share of whisky increased by a similar percentage from 1.53% to 3.14%. The complainants conclude that this transfer of market share from soju to whisky shows that the two liquors are in competition with each other on the Korean market.

1.142. The complainants further explain that this trend may have reversed itself during 1997 as a result of the depreciation of the Korean won, the campaign of boycotts against imported products and the financial crisis of last autumn. According to the complainants, this reversal of market trends constitutes an additional proof of the substitutability between soju and imported western-style liquors.

(d) The Dodwell Study Shows that there is a Significant Degree of Cross-Price Elasticity Between Soju and All other Distilled Spirits and Liqueurs

1.143. The complainants presented a document,⁹³ which purports to contain a copy of a study completed on 17 July 1997 for the Confederation of European Producers Spirits by Dodwell Marketing Consultants Ltd in co-operation with Frank Small and Associates, Korea ("the Dodwell study").

1.144. The complainants argue that the purpose of the Dodwell study was to test the hypothesis that a reduction in the prices of western-style spirits and liqueurs and/or an increase in the prices of soju following a change in the applicable liquor tax rates will lead to a relative increase in the consumption of western-style liquors at the expense of soju.

1.145. According to the complainants, the research method used in the Dodwell study is the same as that followed in the ASI study, which was cited by the Panel on Japan - Taxes on Alcoholic Beverages II as one of the reasons for its conclusion that shochu and all other spirits and liqueurs were competitive in the Japanese market.⁹⁴

1.146. The complainants further state that the Dodwell study is based on the responses to questions from a representative sample of 500 Korean spirits drinkers. The complainants also state that the survey-takers showed to each respondent pictures of representative brands of soju, premium soju and three brown spirits (standard scotch, premium scotch and cognac) and a list of prices for each, and asked which type of beverage the respondent would most like to buy given the prices specified.

1.147. The complainants argue that initially, both the proposed price for standard soju and the proposed prices for the other beverages were based on current representative prices on the Korean market ("Level 1" prices). The prices for soju were then successively increased to "Level 2" and to "Level 3". At each of the three price levels for soju, the prices for the other beverages were reduced in two steps ("Level 2" and "Level 3"). Thus, the complainants argue that the respondents were confronted with nine different price combinations. All the prices proposed to the respondents were within the range of the price levels which could reasonably result from the elimination of the existing differences in tax rates. The same research was carried out also with respect to the main types of white spirits (gin, vodka, rum and tequila) and liqueurs.

1.148. The complainants argue that the Dodwell study confirms that there is a significant degree of cross-price elasticity between soju and brown spirits, as allegedly evidenced by the following findings:

1.149. The complainants also argue that the Dodwell study shows that cross-price elasticity between soju and white sprits and liqueurs is also significant. Thus, it is alleged that according to the study, if the price of soju was increased by 200 won to Level 3 and, simultaneously, the price for white sprits and liqueurs was reduced to Level 3, the share of consumers who would prefer white spirits and liqueurs to soju (including premium soju) would increase from 13.8% to 23.8% (i.e. by 72 %).

ii) Soju and other Distilled Spirits and Liqueurs are "Not Similarly Taxed"

1.150. The complainants note that, as confirmed by the Appellate Body in Japan - Taxes on Alcoholic Beverages, for two competitive or substitutable products to be deemed as "not similarly taxed", the difference in taxation must be more than de minimis ⁹⁵. The complainants further notes that in the same report, the Appellate Body held that whether any particular tax differential is or is not de minimis must be determined on a case-by-case basis⁹⁶.

1.151. The complainants presented the following table which purports to show the differences in taxation between each of the sub-categories of soju and the other categories concerned in this dispute. According to the complainants, the table evidences that diluted soju is taxed at the lowest combined rate, whereas distilled soju is taxed at a lower combined rate than any other category with the only exception of "liqueurs".

1.152. The complainants conclude that table 5 provides evidence that the differences in taxation are in all cases far from being "de minimis" and, therefore, that soju is not "similarly taxed". According to the complainants, the combined tax rate on whisky and brandy, for instance, is 2.36 times higher than the rate on distilled soju and 3.38 times higher than the rate on diluted soju.

iii) The differences in Taxation are Applied so as to Aford Protection to the Domestic Production of Soju

1.153. The complainants note that in Japan - Taxes on Alcoholic Beverages II, the Appellate Body laid down the following approach for establishing whether dissimilar taxation of directly competitive or substitutable products is applied "so as to afford protection to domestic production":

Although it is true that the aim of a measure may not be easily ascertained, nevertheless its protective application can most often be discerned from the design, architecture and revealing structure of a measure. The very magnitude of the dissimilar taxation in a particular case may be evidence of such protective application, ... Most often, there will other factors to be considered as well. In conducting this inquiry, panels should give full consideration to all the relevant facts and all the circumstances in any given case.⁹⁷

1.154. The complainants argue that in the present case, the following facts and circumstances regarding the "structure of the measures" as well as its "overall application on domestic as compared to imported products" constitute irrefutable evidence that the Liquor Tax Law and the Education Tax Law are applied "so as to afford protection" to Korea's domestic production of soju. For this proposition, the complainants gives the following factors:

⁸⁷ Appellate Body Report on Canada - Certain Measures Concerning Periodicals, supra., p. 28.

⁸⁸ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.7

⁸⁹ See Panel Reports on Japan - Taxes on Alcoholic Beverages I, supra., para 5.7; and on Japan - Taxes on Alcoholic Beverages II, supra., paras 6.28 to 6.32.

⁹⁰ See EC Annex 10.

⁹¹ See EC Annex 11 and US Exhibit G.

⁹² See the advertising materials included in EC Annex 12 and US Exhibit G.

⁹³ See EC Annex 13.

⁹⁴ See Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., paras 6.29 and 6.32

⁹⁵ Appellate Body Report on Japan - Taxes on Alcoholic Beverages, supra., p. 23;

⁹⁶ Ibid.

⁹⁷ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 29.